Many people think that if they have a will or a trust their estate plan is complete. However, many people own assets that are governed by beneficiary designations that are probably not governed by their will or trust. IRA’s,403(b)’s 401(k)’s, other qualified retirement plans, life insurance policies, annuities, payable on death accounts (POD’s), and transfer on death accounts (TOD’s) are beneficiary designation property. These assets are paid to the individuals or entities that you name to receive them (designate) when you die. They are sometimes referred to as "non-probate" assets because they are usually distributed outside the probate process. It is most important for you and your clients to check all beneficiary designation assets to make certain they are up to date and correct. In my practice, the majority of my clients have reported incorrect or out of date designations on their beneficiary designation assets. Last year, following my own advice, I reviewed my own beneficiary designation assets. I discovered that five out of seven beneficiary designation accounts were either incomplete or just plain wrong.
Beneficiary designations should be reviewed on a regular basis especially if there is a change in life circumstances. Significant life events, such marriage, divorce, the birth of a child, or the death of a loved one might be cause for a change in beneficiary. Beneficiary designations should also be checked if a person’s employer has changed retirement plan providers or insurance providers because the beneficiaries previously chosen might not carry over to the new provider.
Here are some things to consider with beneficiary designation property:
• First, make certain you have both primary and secondary beneficiaries. Ask yourself ‘who do I want to have these assets if my first choice were to die before I do?” If you have not named a secondary beneficiary and your primary beneficiary predeceases you, the company where your beneficiary designation assets are held will determine who inherits. Usually your property is given either to your heirs at law or to your estate.
This can lead to unintended consequences. For example, you might be trying to avoid having your loved ones go through probate when you are gone. If there are no beneficiaries designated when you die the assets might, by default, be left to your estate and a probate might have to be opened in order for the assets to be distributed.
• Second, many parents want to leave beneficiary designation property to their children. The designation “all my children” is usually acceptable but what happens if one of the children were to die before they do? It raises the question of how that child’s share should be handled. If they want that child's share to go to their descendants, then they should use the words per stirpes in the designation. If they want the deceased child’s share to go to the other children, then they should use the words per capita in the designation.
• Third, never designate a trusted friend or relative with the assumption that the person will “know” how to distribute your assets in accordance with your wishes once you are gone. For example, you might want to designate the oldest child with the idea that he will share the money equally with his siblings. That child could keep the money for himself; he is under no legal obligation to share it. If he does follow your wishes and shares the money he has now made a gift to his siblings which could create a gift tax problem for him if the amount of money left to him was large.
• Fourth, be careful when designating a person who has special needs. Unfortunately, some disabled people have to rely on government benefits in order to get by. If they receive an inheritance outright it could affect their eligibility for government programs. They could lose their benefits. In this situation some consideration should be made to creating a special needs trust to be the beneficiary of the assets for the benefit of the disabled person.
• Fifth, consider using percentages when designating beneficiaries. Some people like to leave a specific dollar amount to someone. For example, a designation might state something like “$100,000 to my niece Jennifer and the rest to my nephew Tom.” This might not be an issue if there is a large amount to be left. But, what happens if the person leaving the gift spends down the money in the account and there is only $80,000 left at the time of death? This means Jennifer will get it all and Tom will get nothing. A better way to do it is to leave each beneficiary a percentage of the whole amount.
• Finally, be very careful when designating your IRA’s. If you designate your trust as the designated beneficiary of your IRA you must make sure the trust has special language accepted by the IRS. Otherwise your beneficiary might have to take the money in a lump sum and pay a huge income tax. They might not be eligible to stretch out the IRA payments over time.
Beneficiary designations are a key component in any estate plan. Make sure they conform with your overall estate plan and are titled to avoid unintended consequences.