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Planning for worst case scenarios is the reason why we get life insurance in the first place.  But could some simple wording changes on your life insurance beneficiary form make a big difference?  It could make the difference between the court sitting on the money until the child turns 18 instead of the person you trust being able to immediately use those funds for your child’s benefit.

When discussing options for life insurance policies, retirement accounts (IRA’s, 401k’s, etc.), and in naming beneficiaries in a will or trust, there are three options, which I’ll take in order of simplicity.

Option 1: Naming The Child Directly, After The Spouse

You can name your children specifically or as a class, for example, “all my children.”  This effectively puts the court in charge of the funds until the child reaches adulthood at age 18.  You’ll have to go to court, and request that they appoint a guardian who will manage the funds under the court’s supervision.  The formal procedures that the guardian will have to comply with in order to utilize the funds, however, make it difficult for the guardian to use the money effectively except for the most obvious needs.  After the child reaches the legal age of adulthood, 18, the court then turns the entire account over to them.  Needless to say, this isn’t an ideal option.

Option 2: Use an UTMA Designation

With some simple additional language, the beneficiary designation can specify a custodian to manage the money under the California Uniform Transfer to Minor’s Act.  The custodian is free to proceed without the court’s supervision, which can be a good or bad thing, depending on the skills and faithfulness of the custodian.  However, aside from relieving some of the burden of the formal procedures a guardian faces from court supervision, the same problem of the custodian’s control terminating upon the child’s 18th birthday applies to UTMA accounts, unless you specifically authorize the custodian to act until age 25.

Using an UTMA account has the benefit of being cheap (you don’t need an attorney to set one up) but it does have some limitations.  You’ll need one account per child, meaning you can’t have a “family” account until the children reach a certain age.  And you can’t give any directions or limitations on the custodian’s use of the funds.

Option 3: Use a Trust

A trust is more complex, but also the most flexible of the three options.  The trustee won’t have the formal reporting procedures to the court that restrict a guardian.  And in setting up the trust, we can give the trustee specific instructions.  And most importantly, we don’t have to terminate the trust when the child reaches adulthood, but can choose from a number of options in paying out the funds for our children’s benefit. For my wife and I, choosing a trust makes the most sense.  Using a number of financial tools, we hope our two boys will be well prepared for college and beyond.