Why You Should Not Name Your Children (and Maybe Not Even Young Adult Children) as Direct or Contingent Beneficiaries on Life Insurance IRAs and Other Accounts

Written by: Wills, Trusts, & Estate Administration

You wonder if you read that correctly, don’t you?  It probably seems like a no-brainer, naming your spouse as primary beneficiary and your children as secondary or contingent beneficiary on life insurance policies, IRAs, annuities and similar items.  After all, in doing so, the assets (eg, life insurance proceeds) will pass outside of probate. That’s a good thing, right?

Actually, this is most often not advisable, and it is  instead preferable to name your estate as the contingent beneficiary, and have in place a valid Last Will and Testament.

Why is this?  There are actually several reasons why this is not advisable, but the greatest reason is that a conservator will have to be appointed for your minor children.

Many people think it is a hassle and large expense to probate  a Will.  (It generally is not.  See my article “The Basics of Probate and Estate Administration”).  Additionally, not having a Will does not mean your estate will not have to go through the probate process (see my article “Why Everyone Needs a Will”). In most cases, your estate will have to be administered through the court regardless of whether or not  you have a Will.

As noted above, probating a Will (at least in Georgia and Alabama), is neither overly burdensome nor particularly expensive.  Want to know what IS a burden  and  IS expensive? A conservatorship for a minor child, which is what will have to be done if property and assets pass directly to a  minor child at your death.  The creation of a conservatorship involves a petition to the probate court to appoint a conservator, the payment of an annual bond, the filing of annual returns and reports to the court each year that the child is a minor, seeking court permission through a separate filing to sell an asset or change investments, accounting to the court for every dollar spent, and finally a petition to dismiss the conservatorship upon the child becoming of age.

Here are some other specific instances why naming the child outright might not be such a good idea:

1. Ensuring funds are available for education and other uses

If you name your children, whether minors or young adults, as the direct contingent beneficiary, there is no assurance they will wisely use those funds for college, or to assist with a down payment on a home, or start a business, or a myriad other legitimate uses.  And as noted above, once they are of legal age, they receive the funds outright from a conservatorship.  And to most parents, age 18 is “too young” to have control over potentially significant funds.  By running these funds through a Will, into a trust created by your Will, you can help ensure your goals for them are achieved and that the money can’t be wasted, squandered, or subjected to their potential creditors for so long as it remains in trust.

2. Children with (or who may develop) drug or alcohol issues

Every parent at some point fears that their child will abuse drugs or alcohol.  Too many see those fears come to reality. With the current Opioid crisis in this country, these fears may be greater than ever.  If you have a child with alcohol or chemical dependency issues, a trust created under your Will can be a way to protect that child from his or her own behavior.  This type of trust may continue for the child’s entire life, it may continue to a set age, or it may continue until the child can demonstrate he or she has been clean and sober for some period of time.

3. Children with (or who may develop) financial issues

Whether it’s prior bankruptcies, foolish spending habits, gambling, risky business enterprises, or other financial issues, one way to ensure that the assets you leave to your child will be there to provide some basic level of support or financial backstop is to leave the assets in a trust created under your Will.  It will be protected from bankruptcies, protected from foolish or irresponsible spending, and protected from being invested in risky enterprises.  These type trusts often provide for either discretionary income in the Trustee’s discretion, or even fixed payments over the term of the trust or the child’s lifetime.

4. Special needs children

My article “Estate planning for parents of special needs children”, touched on this in some detail.  But in terms of planning for a special needs child, a parent (or other generous friend or relative) really only has a few options:  (1) disinherit the child so as to  not jeopardize the individual’s governmental or needs-based benefits, (2) an outright gift to the individual, which will cause a loss of those benefits, or (3) a Special Needs Trust, which will supplement those benefits without causing a loss of the same.  These trusts can be created under your Will, but must be carefully drafted to comply with laws and contain some very specific provisions that you would not see in a ‘regular’ trust.

5. The ex-spouse/other parent.

If you are divorced, and have minor children, and you name those minor children as a direct beneficiary, then as noted above someone will need to petition the court to be appointed the conservator for the assets your minor children will inherit from you.  That ‘someone’ could easily be your ex-spouse, who will have priority in the eyes of the law.  For some of you, that may be just fine; for others of you, you may not can think of anything you’d be less comfortable with.

As a final note, and to capture the parenthetical in the title of this article, what about naming your children as contingent beneficiaries if they are not minors?  Reference back to point number 1. Above, but simply put, that is a decision that depends on your particular facts and circumstances.  But let’s say you have two children, ages 18 and 20.  And they are contingent beneficiaries on your $500,000 life insurance policy.  Are you comfortable with your two young adult children, who have now lost one or both parents,  coming in to and having absolute control over $250,000 each at that age?  If so, then naming them as contingent beneficiaries is appropriate.  If, on the other hand, that causes you some concern, then you should reconsider the benefits of having a Will in place that might put those assets in trust for a few or 5 or 10 (or more in some instances!) years.

Are there any exceptions to the suggestions herein? Not many.  However,   if your estate is likely to be insolvent or have significant creditors, then you might not choose to name your estate as the beneficiary, as that would make these various assets (life insurance proceeds, IRAs, etc) subject to creditors of your estate at your death, where they would generally otherwise not be subject to creditors if passing outright to the beneficiaries rather than passing through your estate and under your Will. If potential estate creditors are a concern, there is a way to avoid that as well, through the use of an Irrevocable Life Insurance Trust (ILIT). See my article “Irrevocable Life Insurance Trusts (ILITs)-What They Are and Why They Are Great”.

In summary, a minor child should most often not be named as the direct (contingent) beneficiary on life insurance, annuities, POD accounts, CDs, IRAs and similar assets that can otherwise pass outside of your Will and the probate process.   The costs associated with an ongoing conservatorship for a minor for those assets are generally far more burdensome and expensive than handling the passing of those assets under a Will to a trust for the child’s benefit.  You should consult with your financial advisor or estate planning attorney as to your particular circumstances.