Are your beneficiaries ready?

Are the beneficiaries of your insurance policies ready to receive an inheritance?  Are they responsible enough to effectively manage a large lump sum?  How would a significant amount of money motivate or change your children?  These are all questions that have led some insurance companies to offer the flexibility to pay death benefits out either through an annuity, as a lump sum or an alternative arrangement.

Here’s how they work:

Lump Sum:  Most insurance products, such as life insurance policies and segregated funds, have named beneficiaries.  Upon notification of the death of the life insured the proceeds have historically been paid out as a tax-free lump sum amount to the named beneficiaries.  Many individuals are hesitant to leave a lump sum to certain beneficiaries.

Annuity Option:  An alternative which we feel individuals should be made aware of, is the ability to pay out the death benefit by way of an annuity.  Generally this is accomplished by completing one simple form and ensures that death benefit proceeds from the insurance product are used to purchase an annuity for the beneficiary.  The annuity may be purchased for a set term or for life.  It may also be deferred or start paying a cash flow immediately.

Educating Beneficiary:  We encourage individuals who are intending to leave significant assets to their children or other beneficiaries to spend time educating them.  In some cases this may involve bringing the beneficiaries into meetings with your investment advisor.  Ensuring your beneficiaries know how to handle a significant gift may be the best gift you leave them.

Illustration:  Mr. Lewis has four adult children, all of whom have taken different paths in life.  He has listed all four as equal beneficiaries (25 per cent) on his life insurance policy.   Based on discussions with Mr. Lewis he chose to treat each child differently with respect to their portion of the death benefit.

Child 1:  Child 1 has had a difficult time maintaining a job and feels that he may not be responsible upon receiving a lump sum inheritance.  Mr. Lewis has decided that the portion of the death benefit proceeds paid to this child should be used to purchase a life annuity.  The monthly payments will be smaller but will last the child’s lifetime.

Child 2: Mr. Lewis felt that Child 2 had consistently demonstrated a hard work ethic and was responsible enough to receive a lump sum inheritance.   He mentioned that Child 2 has already started saving and has done some investing already.   Mr. Lewis felt comfortable leaving this child a lump sum cash amount.

Child 3:  Mr. Lewis noted his uncertainty with respect to how Child 3 would deal with a lump sum inheritance.  Mr. Lewis felt that a twenty-year term certain annuity would likely be more suitable for this child.

Child 4:  Mr. Lewis is very proud of his fourth child.  He has just reached the age of majority and is planning his university education.  Child 4 is still relatively young but is responsible for his age.  As a result, Mr. Lewis felt that a ten-year term annuity would be the most appropriate to ensure funds would be available to the child to complete his university education.

Mr. Lewis has the flexibility to change how the death benefit portion will be paid out to the respective beneficiaries.

Formal Trust:  The annuity settlement option may provide a solution for simple arrangements without the set up costs of a formal trust.  Individuals with more complex situations or those who would prefer a structured approach should consider a formal trust.

Before implementing any strategy noted in our columns we recommend that individuals consult with their professional advisors.