People can be funny when it comes to money.
Have you ever been out for dinner with a big group of family members or friends? When it’s time to square up at the end of the evening, it’s strange how difficult it sometimes is to get everyone to chip in what they really owe.
Imagine there were millions of Rand involved, rather than a couple of hundred!
Take for instance, a person who passes away and leaves small children behind. Now imagine this same person nominates his or her children as beneficiaries for their life insurance and pension fund benefits.
What happens if you leave your life insurance to your minor children?
In South Africa your child is only recognised as an adult once they turn 18. A four-year-old cannot enter into contracts or manage their finances. You would be stunned if you knew how many people nominate small children as the beneficiary of their life insurance.
So, what happens when you leave the proceeds of your life insurance to your kids?
Does it pay out to the child? Does it pay out to the child’s guardian?
We’ve already covered the fact that your four-year-old can’t get their hands on your life insurance, but imagine if they could? It wouldn’t be long before vultures begin circling.
The same could be said of your children’s nominated guardian. Sure, the guardian loves your kids as much as you do, but how much experience do they have when it comes to investing large sums of money? Are they financially successful themselves? And, what’s to stop them from dipping into your child’s funds in an emergency?
Nothing! That’s the unfortunate reality.
Government realised that neither of these situations were ideal and so they established the Guardian’s fund. The Guardian’s fund steps in when you nominate minors as the beneficiaries of your life insurance and investments. They administer the assets on behalf of the minor child until the child reaches 18. This money is invested with the Public Investment Corporation, raising the question of how safe your children’s money would be.
Can you leave your pension or provident fund saving to your young kids?
Hopefully you’ve completed a beneficiary nomination form for your pension or provident fund. Question is, should you nominate your small children?
How this works is that each fund is managed by a board of trustees. These trustees decide who is to benefit from the proceeds of your fund. This means that someone other than your children could also inherit your benefits if they can prove that they were financially dependent upon you at the time of your death. For the purposes of this article, let’s assume it’s only your kids who inherit the money.
This could go one of two ways. Either the trustees pay the proceeds to the guardian of the children, or they establish a Trust to take care of them until they are old enough to manage their own affairs. It is entirely possible that the fund proceeds – and your group life insurance – will pay to your children’s legal guardian.
Clearly, this isn’t ideal, and it would be wise to indicate on the beneficiary form that you desire for a Trust to be set up for your kids’ benefit.
An option you can consider is establishing a Trust.
Trusts have a number of uses, but one of the more important ones is to look after the assets of those unable of looking after themselves.
But starting a Trust could require money you don’t have right now and can also be a hassle to maintain since tax returns need to be submitted annually.
Is there another option?
Yes, there is and it’s called a Testamentary Trust.
A Testamentary Trust only comes into existence upon the death of the Founder. What happens is that you need to have a Last Will and Testament drafted by either a Trust company or by an Attorney. Within that Will you’ll state that a Testamentary Trust is to be set up for the benefit of your children upon your passing. You can then decide on an age when each of your children will inherit their share of the proceeds.
A Testamentary Trust is particularly useful when combined with life insurance.
Instead of nominating your children as the beneficiary, you nominate your Estate as the beneficiary of your life insurance. Then in terms of your Will, the proceeds are payable into the Testamentary Trust for the benefit of your minor children.
One drawback of a Testamentary Trust is that it costs money to maintain a Trust for ten or twenty years. Leaving a million Rand to look after your kids for twenty years might not even come close to covering these costs. Discuss these costs with the Trust company and make provision for them by increasing your life insurance appropriately.
Of course, there is a danger when nominating your Estate as the beneficiary. Your Estate might have other debts to pay. These debts will then be paid from the life insurance proceeds leaving less available money for the Testamentary Trust.
Leaving large sums of money to a guardian can be a massive temptation. People fall on tough times and it’s easy to dip into the funds with the intention of paying it back sometime in the future.
Don’t place that sort of stress on your kids’ legal guardian. Instead have your Last Will and Testament drafted containing the requirement for a Testamentary Trust. Then nominate your Estate as the beneficiary for your life insurance.
But just make sure that you have enough life insurance to take care of three things:
- Sufficient money to take care of the income needs of your kids
- Sufficient money to settle any debts you might have, and
- Sufficient money to cover the cost of administering the Testamentary Trust
Until next time.
The Wise About Life Team.