28 Jul Protect Your Life Insurance Payout from Creditors with Trusts: Part 2
By: Barry E. Haimo, Esq.
July 28, 2015
Protect Your Life Insurance Payout from Creditors with Trusts: Part 2
While it may sound like a straightforward decision, choosing a beneficiary for your life insurance policy can be a tricky endeavor. Choose poorly, and you could end up causing a lot of complications and stress for your survivors.
In a previous post, I talked about a situation where your life insurance payout may be vulnerable to creditors, and discussed strategies for protecting yourself from them. But creditors aren’t the only individuals that could potentially pose a threat to your life insurance payout. In certain situations, your chosen beneficiaries themselves can be a danger to your life insurance policy proceeds.
To illustrate how this could happen, I’ll use the example of the Imada family.
The Black Sheep Beneficiary
“I guess there’s a black sheep in every family!” the residents of Allentown, Florida would often quip when referring to Edward, the youngest member of the Imada family.
Linda and Toby Imada had raised two beautiful, well-adjusted girls who had both gone on to attend Ivy League schools up east, but Edward was—well, Edward was different. Though certainly a bright and gifted guitar player, Edward always had a sullen look on his face and a knack for getting into trouble.
Throughout middle school and high school, he gained a reputation across town for cutting class and smoking cigarettes outside the neighborhood deli with other saggy pants-clad juvenile delinquent types. He was even arrested for shoplifting and underage drinking a few times, though charges were never filed.
Hardly anyone could fault Toby and Linda Imada, who were law-abiding church-goers who loved their children and seemed genuinely bewildered by their son’s behavior. Everyone was heartbroken when Toby and Linda were killed in an unexpected car accident, leaving behind two young adult daughters and Edward, who had just had his 18th birthday.
Fortunately, Toby and Linda had taken out a life insurance policy that left their children well-provided for. They had named each of their children as beneficiaries, leaving instructions that the proceeds should be divided evenly between them.
But while the two Imada daughters put the proceeds towards their college tuitions, Edward was a little overwhelmed by his sudden wealthy status. He hadn’t had the grades or the drive to apply for college, and had been working part-time as a mechanic at a local garage.
Grief-stricken and unsure of what else to do with himself, Edward quit his job and began drinking heavily. He threw massive parties at his parents’ old house, entertaining all sorts of characters and lowlifes—much to the dismay of his neighbors.
Rumors about his new lifestyle quickly spread across town. Not only was Edward reportedly drinking, but several sources alleged that he was getting into harder substances: marijuana, cocaine, and even heroin. Sure enough, one of Edward’s many parties was busted by local police officers, who found several different types of illegal substances on the premises.
Edward and a few other party guests were arrested and taken into custody. Although Edward managed to get off with a light sentence, he did end up having to pay thousands of dollars in fines.
Within a year, Edward’s portion of the life insurance proceeds had run out. The residents of Allentown were certain this was the end of the road for him. Mercifully, he was able to get his job at the mechanic’s back, and he managed to keep his parents’ house. Edward would never live as comfortably as he had before, but over the years he began straightening up. He began working long hours, and saving more responsibly. He even began talking about applying to community college soon.
“Some people just have to learn the hard way!” the neighbors agreed.
A Better Beneficiary
How could the Imadas’ situation have been avoided? The Imada parents made an excellent decision to take out a life insurance policy, but the problem lay in the way they named their beneficiaries. While it’s understandable that Toby and Linda wanted to leave each of their children with a financial cushion, leaving young adults with a huge sum of cash isn’t always the wisest idea.
A better strategy in the Imadas’ situation may have been to name an irrevocable trust as the beneficiary for their life insurance policy instead. When setting up a trust, Toby and Linda could have named a trusted adult figure as trustee to manage and spend the money for their children’s health, education, maintenance and support, or “HEMS.” That way, all of their children would benefit from the proceeds of their policy, but at a steady, carefully controlled rate. This would have protected and preserved the value of the trust estate for the beneficiaries.
If you are considering taking out a life insurance policy, consult with an experienced estate planning attorney. Have him or her collaborate with your financial planner. Your attorney can guide you through the process of naming a beneficiary, helping you determine the best individual or entity to name. If you decide that naming a trust is your best route, your attorney can help you create one with specific instructions on how and when the money should be distributed, and to whom.
Barry E. Haimo, Esq.