Your Children and Life Insurance

My husband and I separated in March 1999. At the time, we each had $250,000 of life insurance. In our separation agreement, we specified that we would make our minor children (now eight and seven) the irrevocable beneficiaries of that life insurance. My understanding was that this meant that neither my husband nor I could change the beneficiary without the other's signature. I was wrong.

In April 2000, my husband died unexpectedly of pneumonia at age 37. We were still legally married. We both thought that the life insurance money would be available to the surviving parent if either of us died, to use to support the children as they grew up. However, because we named the children as irrevocable beneficiaries, I can't touch the money to use on their behalf. All I am legally allowed to do is to invest for them until they are 18. And the legal hoops I had to jump through to get that privilege were unbelievable. The process is horrible, time-consuming and expensive!

When I contacted the insurance company, they asked whether a trust had been set up in the children's name for the insurance proceeds. I said no, because neither my husband nor I knew we had to do that. Now I have to petition the court to name me guardian of my children's financial interest. But the court won't do that until I have obtained a surety bond from an insurance company guaranteeing that I will not spend the money but instead hold it until they are 18. Apparently the insurance companies have had losses on this kind of guardian bond, and they required my sister to become joint-guardian with me.

I must pay $6,000 in premiums to the insurance company to ensure that during the next 10 and 11 years I will not spend my children's money. Both my sister and I have to appear in court to swear before the judge that we will not spend my children's money. Once I receive the money, I must earn a certain rate of return, or I am liable for the shortfall. I must also submit bi-annual accounting reports to the court on earnings and disbursements. I am working with a certified financial planner to set up guardian brokerage accounts for the children. These are different from (and more complicated than) trust accounts, which are the typical minor accounts. All in all, it has been a nightmare.

Next page: Read the conclusion of this member's story and then our expert's advice about naming benificiaries.

The silver lining is that I am going to designate that money for my children's college education. This will make my financial planning a little easier, because now I don't have to worry about that particular expense down the road.

I have also learned a valuable lesson about the disposition of my own life insurance. My older sister is the guardian of my children under my will if anything should happen to me. I have changed all of my beneficiary designations so that she is the sole beneficiary of my insurance and death benefits. If I should die while my children are still minors, she will have immediate access to the money she needs to raise and support my children. I am trusting her with my most precious asset, my kids, so I figure I can also trust her to use my death benefits in their best interest. I would encourage everyone with minor children, married, separated, or divorced, to make the guardian of your children the beneficiary of your life insurance and other death benefits.

The caveat here is that designating your children's guardian as beneficiary of the life insurance is fine if your kids are young, but as they get closer to adulthood, it may constrain their guardian's ability to disburse the money. Since it will be the guardian's money, he or she won't be able to give your children more than $10,000 each a year without incurring gift taxes.

The recommendation from my financial adviser is to set up a trust for the children, making the trust the beneficiary and your children's guardian the trustee with the ability to use the money in any way for their welfare. I would also encourage anyone who is writing a separation agreement to consider how your spouse or ex-spouse's death would affect the agreement. I hope that readers can learn from my example and avoid the same difficulties.

Read our expert's response to this member story about the importance of naming your benificiaries correctly.

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