Got Life Insurance? Beware of Choosing the Wrong Beneficiary.

Naming your loved ones as beneficiaries may turn good intentions into wrong outcomes.

Dick and Jane just bought their first home. Concerned about the well being of his wife and two toddlers, Jack and Jill, Dick decides to get a life insurance policy in case something happens to him. He figures with $1 million Jane can pay off the mortgage, set some money aside for the kids' college funds, and leave enough for them to rebound after several years of adjusting life without him. So he calls his financial adviser and gets life insurance. Now he can check that box: Something happens to him, Jane gets enough death benefits to carry on with the kids.

Fast forward 15 years later. The mortgage is still half way through. To keep up with expenses, Dick and Jane work full time. The kids will soon graduate from high school with underfunded college savings, but that's OK, their combined income plus some student loans should help them get in a decent school. Soon they will get serious about saving for retirement.

So far, nothing out of the ordinary.

Life, however, decides to throw them a curved ball and Dick dies prematurely. Hey, at least he had the foresight way back then and got his family covered.

As the designated beneficiary, the insurance company cuts a $1 million check to Jane; money which is now sitting in the bank waiting to be put into much needed use. So far, everything is going as planned.

Jack, now 17, borrows the family car to get some groceries. While checking his Instagram he rear ends someone injuring him - hopefully not that serious. The driver meets with a personal injury lawyer, who after learning that Jane's $1 million is sitting in the bank, takes the case on a contingency basis and sues Jane for damages, lots of them. They win a judgment that easily surpasses her umbrella policy and raids the death benefits. Sadly, still nothing out of the ordinary.

That life insurance Dick dutifully paid year after year, ended up for the wrong beneficiary.

You see, owning substantial assets is as if wearing a hat with a big bull's eye and the caption "sue me." The more assets you own, the more attractive you become to potential plaintiffs. The corollary is also true: the less assets you own, the less likely potential plaintiffs will be interested in suing you, or at least settle under reasonable terms.

Which brings me to the unfortunate Instagram incident and how to avoid such a devastating outcome: firstly never text and drive, and secondly consider naming a trust as the beneficiary of the insurance policy. In fact, anyone owning a life insurance policy should establish a trust to ensure their loved ones will effectively be protected. Let me explain.

Two types of trusts can successfully shield death benefits of a life insurance policy: revocable living trusts and ILITs (irrevocable life insurance trusts). The former is easier and less expensive to set up and maintain than the latter which is often used for high-net-worth individuals. So, to keep it simple let me drill down on revocable trusts.

For that, let's step back in time when Dick gets the life insurance policy. He sets up a revocable living trust, names Jane as the beneficiary of that trust, and in turn names the trust as the beneficiary of the insurance policy. When Dick dies, the trust becomes irrevocable (since he is not around anymore to revoke it). The insurance policy then writes a check to the trust, not to Jane. Jane is no longer wearing the bull's eye hat, in fact, Jane has no assets to speak of thus unattractive to potential plaintiffs. Even stubborn plaintiffs will find that suing her is a waste of time since she can file for bankruptcy if necessary - the death benefits remain shielded and will be put into good and intended use regardless.

It gets even better. Jane eventually rebounds and remarries to someone with kids of his own. Dick's now-irrevocable trust will protect the death benefits from bleeding into the new spouse's bloodline by directing trust disbursements for the exclusive benefit of Jane, Jack and Jill. Without this arrangement Dick has no assurances that Jane will take the necessary steps to ensure the benefits go to the intended beneficiaries.

If you have a life insurance policy naming an individual, consider setting up a trust as a means to ensure you are covering the intended beneficiary. Give us a call at 305-924-2918 or email us at dcoriat@strategic-a.com so we can provide you with specific details of how you can achieve it.