HOW TO PROVIDE FOR YOUR CHILDREN WHEN YOU ARE GONE
(MONEY Magazine) – It's one of those worries that dance on your chest in the wakeful wee hours of the morning. For Mary and Claudio DeBaggis of Mercerville, N.J., the watershed event was the birth of their twins, Michael and Mary, three years ago. Suddenly they had three kids instead of one--their eldest child Katie had been born in 1991. Recalls Mary, 36: "It dawned on us that all of them depended entirely on us. What would happen to them if we died?"
Obviously, these thoughts are dreadful ones--so depressing, in fact, that only one in seven adults even has a valid will. But concern spurred the DeBaggises to action, as it should spur you. They visited a lawyer who specialized in estate planning to draft a will and set up a trust to hold their children's inheritance. Last spring, even before Mary knew she was pregnant with their fourth child, Alanna, born eight months ago, they also beefed up Mary's life insurance.
As the DeBaggises discovered, providing for your children in the event of your death is not a complicated process. What most assuredly is complicated is the havoc you will bequeath if you don't plan. For instance, your children could wind up being raised by a relative whose values you abhor and whose devotion to the kids you question. Or the money you intended for them might be shared with children from your surviving spouse's remarriage. Says estate-planning attorney Jonathan David of the law firm Kelly Henkel David & Missad in Grand Rapids: "I can't stress enough how planning today can save your loved ones a lot of money and misery later on."
We're going to walk you through the steps you need to take to safeguard the financial and emotional future of your children. It's a walk you owe to your children to take, even if you think you have been through it before. Start by asking yourself the most basic question:
--Whom do I want to bring up my children? If your kids are under age 18, choosing a guardian is the most meaningful decision you need to make. What's important to you: someone who shares your religious beliefs and ethnic background; someone who is college educated; someone who is married with a family? Says Carol A. Harrington, an estate-planning attorney at McDermott Will & Emery in Chicago: "At this part of the planning process, parents are really asking themselves, 'Who will love my kids and raise them in a way that's closest to how I would have raised them?'" It's nice if this person is financially savvy, but that's not essential. You can always appoint someone else to manage the assets you leave the kids.
You may have the serene belief that your cousin would love your kids as her own if you and your spouse died. But unless you have a will in which you nominate her as guardian, a judge of the probate court will assign a guardian based on his or her best judgment--or on whether someone petitions the court for the job. You can guess the result: The person who ends up raising your children may not be the person you would have chosen. You can avert that disheartening prospect by paying a lawyer about $100 to $500 to draft a will in which you appoint a guardian. (The cost will depend on the complexity of your situation and your wishes.) Be sure to name at least one successor guardian in case your first choice dies or flakes out.
Before you appoint someone, make sure that he or she is really willing to serve. Auntie Mame to the contrary, "Guardian is not an honorary title," says Jere Doyle, estate-planning manager at Mellon Private Asset Management in Boston. Don't be too quick to nominate your children's grandparents either, however devoted they are. Says Doyle: "There's a tendency to name your own parents as guardians because of the emotional attachment, especially when the children are little and your parents are relatively young. But when the time comes, your parents may be facing advanced age and poor health."
After the DeBaggises weighed the pros and cons of relatives on both sides of their family, they chose Claudio's cousin Vito Rossi, 39, and Vito's wife Mary Lyn, 38. Says Mary: "They're terrific parents whose own four kids are happy, outgoing and do well in school--all the things I want for my kids." In addition, it was important to Claudio, 41, that the guardian share his Italian heritage. The couple decided on Mary's brother Mark, 38, and his wife Liza, 35, as successor guardians. Once the Rossis and their successors agreed to be the guardians, the DeBaggises drafted their will.
If you're a divorced parent with custody, your children will automatically go to your ex-spouse unless his or her parental rights have been legally terminated. But you should name a guardian anyway, in case your ex dies before you or can't be found. Moreover, if your children have been physically and psychologically integrated into a new family with half or stepsiblings, naming your current spouse as guardian may exert a moral, though not legal, force over your ex to let the children remain where they are. After Maureen Mahoney, 35, was divorced in 1992, she named her mother Claire Anderson, 59, as guardian of her two children Caitlin, 7, and Kevin, 6. She selected her sister Julie Giacchino, 34, as successor guardian. "Not only are my mother and my sister the people I would want to raise my children," the Bostonian says, "I've also let them and everyone else know that they should fight tooth and nail for custody of Caitlin and Kevin."
Over time, your initial choice of guardian may seem inappropriate or your children may form a special bond with someone else. If that happens, have your lawyer revise your will to select a new guardian. If your children broach the subject of their own fate in the event of your death--as Maureen Mahoney's son Kevin did--or if you think they are mature enough for you to bring it up, ask them whom they would like to live with if you died. Otherwise, the trauma of your death may be compounded for them by having to live with someone they don't love and can't even like.
--Where will the money come from to see my kids to adulthood? Unless you've built an impressive investment portfolio, you'll need life insurance to replace lost income and maintain the kids' standard of living. If both spouses work, each of you needs coverage, as does the stay-at-home spouse. If (Mr.) Mom dies, you'll have to pay a housekeeper until your kids are old enough to take care of themselves. Claudio DeBaggis is his family's primary breadwinner, and he has $500,000 worth of term insurance; Mary DeBaggis, who works half time as an office specialist at Princeton University, has a $120,000 policy in addition to the $35,000 in coverage she has through a group life insurance policy at her job.
If divorce is imminent and you will be receiving alimony or child support, you should negotiate a requirement that your ex have enough insurance to make up for the payments that would stop if he or she died. Maureen Mahoney's settlement, for example, requires her former husband to maintain a $250,000 policy with the children as beneficiaries. If your decree doesn't specify that your ex has to have life insurance, you may be able to take out a policy on him or her, as long as the ex is willing to meet any requirements that the insurance company might impose, like a physical exam, before issuing a policy.
As a rule of thumb, you need enough insurance to replace six to eight times your annual salary. But don't follow this rule blindly. The proper amount of coverage also depends on the number of children you have, their ages, your plans for their future, your debts and your other assets. Do you want to send them just to college or to graduate school as well? (If the latter, that's $20,000 to $80,000 more at today's prices.) Can you bear to think of them working in college, or do you want them to have a free ride? (Add another $20,000 to $40,000.) Don't forget to factor in the immediate expenses that would result from your death, such as the costs of a last illness and a funeral and burial, which can range from $5,000 to $10,000.
Once you know how much coverage you need, your best bet for getting the most amount of insurance for the least amount of money is term insurance. A typical policy that pays $500,000 on your death would cost a nonsmoking 35-year-old man around $485 for the first year and a female nonsmoker of the same age $455. The premiums rise as you age to $585 for a 40-year-old man and $555 for a 40-year-old woman and $1,495 and $990 for 50-year-olds. By comparison, a universal life policy with the same death benefit and an investment account would cost about $3,660 annually for a 35-year-old man and $2,880 for a woman of the same age.
--How should the children's inheritance be managed? In your will, you can name a guardian of the property to manage the money. This can be the same person as the guardian who will raise your children. Or you can name a family member or friend who is familiar with your financial goals and whose investing acumen you trust. Select a successor guardian of the property in case your first choice is unable or unwilling to perform the job. Obviously, the children's guardian and the guardian of the property should get along and be willing to work together for the good of the children.
Unfortunately, you could be exposing your children to a lot of hassle if you go no further than to name a guardian of the property. Reason: Before the guardian can spend any money or make investments on behalf of your children, he or she must render an accounting to the probate judge and be supervised. This may stop an inept or dishonest guardian from squandering the money, but the process can also be time consuming and invasive. Worse, the guardian has no legal say over what happens to the assets once your kids reach the age of majority, which is 18 in most states. "So," says Jonathan David, "if your sweet newborn has turned into a rebel teen by the time he reaches 18, he'll nevertheless get complete control over the money you left him." Good-bye, college; hello, convertible.
For these reasons, estate planners advise that you create a trust to hold the life insurance payout and other assets that will go to your children. You appoint a trustee to manage the inheritance, and that person is obliged to follow the instructions you have laid out in the trust document. Unlike a guardian, a trustee does not need court approval to carry out your wishes, and you can stipulate in the trust document the age at which your children get their money.
But while the trust is in force, your trustee will ultimately decide how much of your money should be spent for your child and when. Some of those decisions are straightforward: If the kid needs orthodontics, the trust will pay for it. But others require judgment. For example, what if your high schooler wants to spend a semester abroad? Is a semester in Amsterdam appropriate for a 16-year-old when your trust document says money should be spent only for "appropriate" educational needs? The answer: If her teachers think so and the trust can afford it, the trustee would most likely fork it over. So your trustee should be someone whose good sense and objectivity you respect. (For more on choosing a trustee, see the box opposite.) You should still name a guardian of the property in your will, however, in case the trust has to be terminated for any reason before your kids turn 18.
Despite the mystique that surrounds trusts, they can be quite simple: Your lawyer draws up a trust document stating that the property you designate for the trust be used for the benefit of the kids. You provide instructions about how you want the assets managed, including when payouts of income and principal should be made. You also lay out your financial goals for the children--that the trust pay their college tuition, for example, and that any money remaining after that go to them at specified intervals, such as at ages 25, 30 and 35.
You will need to choose between two types of trusts, testamentary and revocable living trusts. A testamentary trust is created in your will and states that your assets are to be placed in the trust upon your death and administered from there according to the wishes you expressed in the trust document. A lawyer will charge you about $250 to $500 for a will that establishes a testamentary trust. A revocable living trust, on the other hand, is created in addition to your will and takes effect while you are still alive. You transfer title to your securities, real estate and other assets to the trust, which you control. You can change the trust provisions, sell the assets, cancel it or even act as your own trustee. Upon your death, the trust assets are managed by the successor trustee you name. Typical cost for a will and a separate living trust: $500 to $1,000.
Which type of trust you choose depends on how costly and disruptive it may be for your survivors to put your will through probate, which is the process of proving that your will is indeed your will and valid. Until the will is probated, the assets it passes on cannot be disbursed. The assets in living trusts do not go through probate because they are created outside the will; those in testamentary trusts do, however, because they are part of the will. Depending on the complexity of your estate and the efficiency of your local probate system, the probate process can take from six months to two or more years and run up legal and administrative fees that cost as much as 8% of the value of the probatable assets, depending on the state. Moreover, probate-court records--including your will--are public documents available to anyone who wants to look them up. You do not want to expose your children to unscrupulous people who might befriend them--or worse--for the money you are leaving them.
A testamentary trust may be adequate if most of your legacy is in the form of life insurance. Assets that have a named beneficiary, as insurance does, escape probate and flow directly to the beneficiary. Similarly, if much of your legacy is in the form of jointly owned property, it will go directly to the other owner upon your death, no matter what your will says. Set up a living trust if you own many different types of assets--securities, real estate and collectibles, for example--or property in more than one state. These create situations that can turn even a fairly efficient probate system into a quagmire.
--What provisions should I make for children with special needs? Be sure to tell your lawyer if you have a disabled child, stepchildren, children from a previous marriage, or any other circumstance that causes your family to diverge from the two-parent, 2.2-offspring mold. You'll find that trusts can be created to meet nearly every need. For example, if your child is disabled, you may need to create what's known as a testamentary spendthrift trust. Unlike the testamentary trust in which you set forth general instructions for your kids' financial futures, a spendthrift trust includes specifically worded clauses that will enable the trustee to spend money on behalf of your child without enriching him to the point where he is disqualified from income-based government programs such as Medicaid.
If you assume that your spouse would remarry after you're gone, and you want to ensure that your legacy goes to your children and not to any children from the subsequent marriage, you can set up a qualified terminable interest property trust (QTIP). Your surviving spouse draws income from the trust, but the principal goes to your children when their parent dies.
There's no way around it: To do right by your kids you have to plan for the worst. But once you've made sure your children are provided for, you'll probably live even longer without the stress of wondering: What if I died and...?