Most people put a lot of thought into the purchase of a life insurance policy. We want to leave behind a financial cushion for our loved ones when we die. By putting equal consideration into the choice of a beneficiary we can further protect our loved ones by ensuring the full benefit of the policy is realized.

What seems like a simple issue is surprisingly more involved than the average person would imagine. The choice of beneficiary can affect your entire estate, have tax implications and also influence the amount of proceeds actually received by the beneficiary.

What you might not realize is that choosing the obvious person, such as a spouse or your children may not always be the best option. If you choose your spouse the proceeds may fall subject to their creditors. If they remarry then their new spouse may deprive your children of the proceeds. If you leave the proceeds to your children then you run the risk of them not being mature enough to handle the money.

There are ways to ensure your life insurance serves the purpose for which you intended. As well, there are mistakes to avoid.

Naming an Individual(s)

Think carefully before naming someone as your beneficiary. Keep in mind the intended use of the proceeds when you do this. If you are unsure of your choice or have questions, an estate planner can assist you in this area. It is possible to have more than one person named. If you choose this option it is better to use percentages rather than exact dollar amounts to divide the proceeds. To avoid future problems if you have multiple beneficiaries it is important to be specific.

It is a good idea to review your beneficiary designations every now and then, especially after major life events such as births, deaths, weddings and divorces.

It is also important to name a contingent beneficiary. If the first person named should die then this person would replace them as beneficiary. If you have no contingent beneficiary and your primary beneficiary is deceased the proceeds of your policy will pass through to your estate and become subject to taxes and fees.

Naming Your Estate

It is generally unwise to name your estate as beneficiary. Doing so will allow the proceeds of the policy to become part of your probate estate. This will increase the amount of estate taxes owed thereby reducing the benefit amount. It will also render the funds unavailable until the will has passed through the probate period and subject the proceeds to all the possible probate problems such as taxes, delays, legal questions and debts.

Don't make the mistake of assuming your will can override a beneficiary designation. If you designate a different person in your will for your life insurance policy than is named on the policy itself then the name listed for the policy will most likely be upheld.

Naming a Trust

With regard to life insurance policies there are different types of trusts. Key types are revocable (RLT) and irrevocable life insurance trusts (ILIT) as well as testamentary trusts.

A testamentary trust is created under a will and becomes active after the grantor dies. It is generally used to manage funds allocated to minor children for education and support but can be a useful tool to manage assets for an adult, or someone who is disabled. Testamentary trusts can also be helpful for young couples with small children who don't have a lot of assets but do have a large life insurance policy, or by those who want to leave money to their children but worry they are too immature to handle a large sum of money. With a testamentary trust there are no upfront or ongoing costs to establish and maintain the trust.

A revocable trust is designed so that you may control the disposition of your assets both during your life and after you die. Factors associated with a revocable trust include:

· Any life insurance proceeds avoid probate.

· Unlike an irrevocable trust, the revocable trust can be terminated or modified at any time by the grantor, and the proceeds are in fact, subject to being includable in the insured's estate.

· If the trust is required to use the death proceeds from the life insurance to pay your estate taxes and debts, the entire death benefit may be included in your taxable estate. The resulting taxes can significantly reduce the amount of the death proceeds available for your family.

Therefore, the majority of life insurance trusts are irrevocable.

An irrevocable live insurance trust (ILIT) or living trust may be preferable for life insurance since the proceeds are removed from your estate and are free of estate taxes. It is, in fact, a legal entity that ‘owns' the life insurance policy. With an ILIT there are certain key points you should be aware of, such as:

· The trust itself becomes the beneficiary of the policy, and the appointed trustee is charged to manage the proceeds for the benefit of named beneficiary. The trustee can be a bank, trust company, or can also be an individual over the age of 18. The trustee is legally obligated to allocate the money with the best interests of the beneficiary in mind, and act as the trust document instructs.

· Once it is set up you cannot change the terms of the trust, beneficiary of the trust, or borrow against the policy.

· It is advisable to have a legal advisor or estate planner help you set up the terms of the trust. You will need to hire a lawyer to draw up the final documents.

· If you transfer an existing life insurance policy into your trust it will be considered part of your estate until three years have passed, so it may be prudent to apply for a new insurance policy and set up the trust at the same time.

Whatever route you choose to follow in choosing your beneficiary, keep in mind the original purpose in purchasing this type of insurance and what your intentions were behind it. This will help you to determine where and to whom you would like it to be bequeathed.

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