It's great to have life insurance to benefit dependent children when your income is lost because of your death, but it's an even better idea to make sure your insurance benefits are used the way you intend.

Setting up a trust for a child beneficiary can ensure that your wishes are carried out. In fact, naming a child as a beneficiary on your life insurance policy without a trust could be downright problematic: A life insurance company will not pay a benefit to someone under age 18 and instead will hold the money (with interest) or pay it to a court-appointed guardian.

A trust is a legal arrangement that gives ownership of assets to one person for the benefit of another. The trustee, or person who officially holds the property for the beneficiary, does not have the right to personally benefit from the trust assets. The trustee must manage the assets responsibly and can be held personally liable for any lost funds.

It may take very little effort on your part to create a trust. For example, in some cases you can simply write, "John Smith, trustee for Susie Jones," on the beneficiary line of a policy. You should check with your life insurance company to see what wording it requires, and also name a guardian and describe the trust in your last will and testament. Once the trust agreement is set up, you can transfer funds or property to it. In the case of life insurance, the death benefit from your policy is transferred to the trust after your death.

The trust agreement should make clear who the trustee is and give the trustee instructions on how to use the money.

A common way for young parents to handle life insurance is to name each other as the beneficiary, but if both die, the money can be put into a trust for the benefit of the couple's children.

Consider special needs children

If your children have special needs and cannot work or care for themselves, your death could leave them to depend on Social Security income. You can set up a trust to ensure that your life insurance funds are used for the children's care. If you give the money to the child outright, he or she could be ineligible for Social Security benefits until the money runs out. With a special needs trust, you can have a trustee pay for everything but essentials such as food, clothing, shelter and medication, which can be covered with Social Security benefits.

Always make sure that the terms of your trust are in writing and that the insurance company is aware of your arrangements. Better yet, consult a lawyer well versed in trusts and estates.