If Tragedy Strikes, Will Your Kids' Financial Needs Be Taken Care Of?

Family insurance
Family insurance

Most parents know how important it is to pick someone to take care of their children in case something happens to them. Choosing a guardian in your will makes it as simple as possible for your children to avoid long, drawn-out court proceedings.

But what about your children's financial needs? Having a plan in place for those, too, can have a profound effect on their near- and long-term well-being. That's why parents need to consider creating a trust to take effect if an unexpected tragedy takes them away from their children.

Your Guardian Can Only Do So Much

While your guardian can spend money to take care of your kids, he or she does not automatically take control of your money. In many states, that's a separate job -- and it may take a court appearance to have funds released.

Not only is that a hassle, but it can also get very expensive. And if you've paid life insurance premiums for years for just this purpose, the last place you want that money going is toward lawyers' fees and court costs.

Creating a trust can make things a lot easier for everyone involved. Here are three big questions you should consider when setting up a trust for your kids.

Who Do You Want to Make Dollar Decisions for Your Offspring?

A trust allows you to do three basic things:

1. Pick someone to manage your children's money.
2. Decide what that person has the right to spend that money on.
3. Choose a time at which your children can manage their money on their own.

Part of creating a trust is picking a trustee. The trustee can be a person or a financial institution like a bank. Picking a family member may be an appealing choice, given that a relative knows your values and can make sure they're instilled in your children. If that family member is also the guardian, then it can seem like the obvious move. Moreover, choosing a family member can be cheaper than paying an institutional trustee.

On the other hand, things can get awkward for a family member acting as trustee. When family dynamics come into conflict with legal obligations that trustees have, the job can get overwhelming. Sometimes, a bank trustee can take away the awkwardness and allow family members to focus on the kids rather than on financial concerns.

How Much Leeway Should You Give Your Trustee?

Most parents try to balance two competing wishes: They want their children to have whatever they need now while also preserving some money for longer-term goals like college or a down payment on a first home. A trust lets you give whatever instructions you want for how the trustee is allowed to spend its assets.

Usually, parents want to give trustees broad discretion to do whatever is necessary. Obviously, you wouldn't want to lock up money if your kids needed it for an unexpected emergency of their own. But by making your wishes known, you can ensure your trustee will have a road map to follow as best as he or she can.

At What Age Do You Want Your Kids to Get the Money?

Without a trust, kids get custody of money left for them when they reach legal adulthood, which is typically either 18 or 21. Many parents think that's a bit young. A trust lets you decide when you want your kids to have full control of their money.

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What the right age is depends on your kids. Some children will be responsible enough to manage money early in their lives, while others may need help well into adulthood. Although many trusts start to make money available when kids turn 25, I've seen some that last until children reach retirement age! That's a pretty extreme choice in most cases, with ages 25 to 35 being the most common range, but it shows that trusts let you do largely what you want -- regardless of whether others would agree with your decision.

Put a Plan in Place

Putting a trust into your will does take some work, and it's not the sort of thing you should try to do on your own. Yet if you expect your kids to have the financial resources they need if something happens to you -- whether that's from your current assets or from life insurance proceeds they'd receive -- then having the right framework in place to take care of that money is essential. Setting up a trust that takes effect after your death can give your kids exactly the protection they'll need to get through a tough time.

Motley Fool contributor Dan Caplinger trusts his family two different ways. You can follow him on Twitter here.