At some time or another, all parents worry about what will happen to their children if one or both parents were to die prematurely. Often, life insurance is the first place parents turn when these worries arise. Although life insurance might be a good source of income for your children if you die, before buying a life insurance policy you should carefully consider whether or not you really need it, what type of policy is best, and who should manage the proceeds on behalf of your children.
Before buying a policy, consider all sources of income for your children if you were to die while they still needed financial support. Those sources might include:
Keep in mind that if you are wealthy or have affluent relatives who would step forward to take care of your children, you might not need life insurance. Or, if you're like most folks and are struggling to pay for your car's brake job or your kid's braces, you can't afford to (and shouldn't) divert much of your current income to cope with the fairly remote possibility that you might die prematurely. (To learn more about whether you should buy life insurance, see Do I Need Life Insurance?)
Avoid expensive cash value life insurance (whole life, universal life, and variable life) policies that offer a lump-sum payment after a certain period of time (20 or 30 years, for example) or after you reach a certain age (often 65). This lump-sum payment is sold as a long-term savings/investment feature and it does nothing to affect how much money will be available to your child if you die in the next few years.
If you're reasonably young and healthy, consider purchasing a moderate amount of term insurance, which is the cheapest form of life insurance. Younger parents can obtain a significant amount of coverage for relatively low cost, for the obvious reason that statistically they are unlikely to die soon, so the risk to the insurance company is lower. It will provide quick cash for your children, if necessary, without draining your bank account now.
If you decide to purchase life insurance for the benefit of your children, you need to arrange some legal means for the proceeds to be managed and supervised by a competent adult. If you don't, and your children are not legal adults when you die, the court will appoint a property guardian for the children. That process necessitates attorneys' fees, court proceedings, and court supervision of life insurance benefits—costs and hassles that surely won't help your kids. There are several ways to prevent this:
There are a few important differences between leaving life insurance benefits to your children under the UTMA and through a child's trust:
Generally speaking, a UTMA custodianship is the most attractive option, unless the amount of insurance is very large and the child will need a property manager past the age of 21. The UTMA custodianship is simpler to set up and manage—and often cheaper (from a tax point of view)—than a child's trust. A UTMA custodianship is particularly sensible for proceeds below $100,000. Amounts of this size are often expended fairly rapidly for the child's education and living needs, and are simply not large enough to tie up beyond the age of 21. If larger amounts are involved and you do not believe the child will be able to responsibly handle the money at the UTMA age limit, a child's trust is a better bet.
For more information on life insurance and children's trusts for your estate plan, read Plan Your Estate, by Denis Clifford (Nolo). For more information about estate planning and will making see Nolo's Estate Planning Bundle.