Why You May Want Life Insurance if You Have Minor Children

"Please sir, may I have another?" - Oliver Twist

Your author does not mean to be morbid. However, we have seen cases where the family breadwinner dies and the surviving spouse and the kids are left in a bad way. We don't want that to happen to people we care about.

Standard Blog Disclaimers:

1. This blog is intended for discussion purposes of general rules in Texas. We are unable to cover MANY exceptions and special cases.

2. Please consult your own attorney and life insurance specialist for advice for your specific situation.

One Way to Think About Life Insurance:

L - L is for LIABILITIES. Life insurance helps ensure your spouse and kids can pay off the mortgage and other liabilities if you pass.

I - I is for INCOME REPLACEMENT. Life insurance can help offset the loss of your income at your passing.

F - F is for FINAL EXPENSES. Funeral and service. Flights and lodging for family.

E - E is for EDUCATION. E.g., college or trade school for your children.

Other uses for life insurance not covered in this acronym:

1. Estate tax liquidity at death.

2. Business succession planning - funding a buy-sell agreement for a closely held business.

3. Special gifts - e.g., down payment for first house, offset costs for marriage for children.

Where Can I Get Life Insurance?

If you work a corporate job you may have access to a discounted group life insurance policy. If you are lucky to be young and insurable these policies are often very affordable for even $1,000,000 of death benefit.

Otherwise, many property and casualty insurers (think home and auto policies) offer life insurance policies.

What Are the Key Provisions in a Typical Life Insurance Policy?

INSURED - this is the person whose life is insured. When the insured dies the life insurance company pays the death benefit amount to the beneficiary of the policy.

OWNER - this is the person who can change the terms of the policy such as naming the beneficiary or changing the amount of the death benefit.

DEATH BENEFIT - this is the amount paid to the beneficiary when the insured dies.

BENEFICIARY - this is the person who receives the death benefit amount when the insured dies.

INSURANCE PREMIUM - this is the amount you pay to keep the life insurance policy in effect. Often paid monthly or in 6 month increments. You are typically trying to get the highest ratio of death benefit per dollar of premium paid.

Life Insurance Example: Rick and Ilsa

Rick and Ilsa are married with two young children. Rick buys a $1,000,000 life insurance policy on his life and names Ilsa as the 100% beneficiary of the policy. If Rick dies, Ilsa will file a death benefit claim to get the death benefit.

After the death benefit claim is processed, the life insurance company will write a $1,000,000 check to Ilsa. Ilsa receives the $1,000,000 free of federal income taxes and can use the money to care for herself and the children.

Technical note: life insurance is exempt from federal INCOME taxes (IRS Form 1040) but IS subject to federal ESTATE (death) taxes (IRS Form 706).

What Type of Life Insurance Should I Get? Term? Whole Life? Universal? Variable?

There are many types of life insurance. We would start with life insurance you can get through your employer (if available) since that life insurance typically gets you the most amount of death benefit per dollar of insurance premium paid.

Term life insurance is often the easiest type of life insurance policy to start with. You should talk to an insurance specialist for more complicated cases.

Pros of a term life insurance policy: you can cancel the policy at any time by ceasing to pay premiums and you often get the most amount of death benefit per dollar of insurance premium paid. Fewest moving parts amongst your life insurance options.

Cons of a term life insurance policy: your term life insurance policy no residual value if you survive the term of the policy. Think of it like a typical comprehensive car insurance policy that pays you nothing if you have no collisions.

Other types of life insurance policies such as Whole Life carry a "cash value" that you can access if you stop paying life insurance premiums. If you get a condition that makes you uninsurable (e.g., cancer) you may not be able to renew a term life insurance policy when the term of the policy is up.

What If BOTH Rick AND Ilsa Die Together? What Happens to the Death Benefit Then? Is it a Good Idea for Minors to Hold Large Amounts of Cash?

We hate these nightmare scenarios. This is where you want your life insurance plan to coordinate with your estate plan.

Your life insurance policy typically has a contingent beneficiary and it would likely say the two kids as 50-5o beneficiaries.

We strongly dissuade you from leaving large sums of money directly to young children. Reasons include:

1. Youthful indiscretion. We have heard stories of high schoolers buying Lamborghinis upon reaching age 18 with inherited money.

2. Guardianship for minors. Texas does not allow you to leave money directly to a minor with a guardian being involved. The life insurance company will almost certainly require the kids to go through an expensive guardianship procedure before releasing the death benefit money.

3. Losing all the money in a divorce. Under the Texas Property Code inherited property starts off as separate property. However, it is VERY EASY to commingle separate property into community property which can get lost in a divorce. You should bet on a divorce attorney worth her salt alleging that inherited property was commingled.

We typically recommend leaving property intended to benefit a minor child in an asset protection trust where YOU choose who holds the money for the benefit of your children and YOU describe HOW the money should be spent for your children in a binding written instrument drafted by your attorney so it holds up in the event the instrument is challenged.

In this context, when we say trust, we simply mean a checking or investment account where a Trustee named by you (e.g., grandparent, sibling, close friend) is the signer for the account and they follow your binding written instructions on how to use the trust account's money for the benefit of your children.

What To Expect Next?

We hope this is helpful! Please don't hesitate to call or email if we can be of assistance creating or updating an estate plan so that it protects your minor children!