Using Beneficiary Designations in Your Estate Plan
For many people, a significant portion of their personal wealth is controlled by financial accounts, such as:
- Life insurance policies
- Tax-favored retirement accounts, such as IRAs and 401(k)s
- 529 college savings accounts.
These types of accounts usually have account provisions that dictate who receives the contents of the account if you die. These provisions are commonly referred to as “beneficiary designations.”
If you have financial accounts with beneficiary designations, those beneficiary designations control the distribution of your accounts when you die, even if you have contrary instructions in your Will or Trust, or if the laws of intestate succession would leave the accounts to someone else. The only exceptions would be if you fail to complete the beneficiary designation, if your named beneficiaries pass away before you, or if you name your “estate” as the beneficiary of the account. As a result, it is critical that you carefully consider your beneficiary designations and make sure that they coordinate with your overall estate plan.
It should be noted that your financial accounts with beneficiary designations are considered part of your estate for tax purposes, even though those assets are not part of your estate for probate purposes.
Advantages and Disadvantages of Using Beneficiary Designations
Using beneficiary designations can be an easy, cost-effective method for transferring wealth to your loved ones. Upon your death, the contents of the account are payable directly to your named beneficiaries, without need for probate proceedings. In addition, there are usually no tax implications to your beneficiaries. Retirement accounts can be an exception; if your beneficiaries want to preserve the tax-advantaged status of the assets in those accounts, they usually need to roll those accounts over into accounts in their own name, rather than take distributions.
However, when you use a beneficiary designation to pass your assets, you are giving up a certain amount of control. You lose the ability to influence how the assets are used by the beneficiary. For example, your Will might include a stipulation that your estate should be used to pay for your grandchildren’s college expenses; if life insurance benefits are left directly to your grandchildren, those funds are not restricted to educational purposes and your grandchildren could use the funds for whatever they want.
Primary Beneficiaries vs. Contingent Beneficiaries
With most financial accounts, your beneficiaries will be separated into two classifications: primary beneficiaries and contingent (or secondary) beneficiaries. Your primary beneficiary has that right to receive the contents of the account upon your death, but that right expires if he or she passes away before you. Your contingent (or secondary) beneficiary is entitled to the contents of the account if the primary beneficiary passes aware before you.
Specific Beneficiaries vs. General Beneficiaries
In naming your beneficiaries, you name very specific people (“my daughter, Jane Doe”), or you can name a group of beneficiaries (“my children”). Naming groups of beneficiaries can be tricky. For example, if you name your children as your beneficiary, do you mean to include only your biological children? What about step-children or adopted children? What happens if a child passes away before you: does their share go to your other children or to their descendants?
Problems with Naming Minor Children as Beneficiaries
Naming minor children as beneficiaries may cause unforeseen problems. Generally, financial companies will not pay death benefits to minors, because children do not have the legal capacity to accept the payment. In that scenario, the funds would have to be held by the financial company until a special bank account (called a Uniform Transfers to Minor Act, or UTMA account) is established for the child or until a court appoints a legal guardian for the child. Both of these processes can be time-consuming and costly to set up. In addition, in both scenarios, the funds would be released to the child when the child reaches 18 years old, even if the child is not yet financially responsible.
Naming Your Estate as Beneficiary
Some people will adopt the strategy of naming their estate as the beneficiary. This strategy has both benefits and potential problems. On the positive side, naming your estate as the beneficiary of a financial account, such as a life insurance policy, can help ensure that the estate has sufficient funds to pay your debts and expenses after your debt. The funds can also be used for specific purposes laid out in your estate plan, such as a college fund for your children or grandchildren. On the negative side, naming your estate as beneficiary means that these funds are exposed to the claims for payment by your creditors.
Your Beneficiary Designations Should Not Conflict With Your Overall Estate Plan
You should take care to ensure that your beneficiary designations coordinate with your overall estate plan. For example, people are legally deemed as adults once they reach the age of 18 and can legally inherit assets. However, many people do not want their children to inherit assets outright at age 18, and want the assets held in a trust until their children are older, perhaps 25 years old. You could go to considerable trouble and expense setting up an estate plan that meets that goal. But, if your beneficiary designations on your financial accounts allow your children to collect the accounts earlier than age 25, it has circumvented your overall estate plan. The better strategy would be to ensure that your beneficiary designations coordinate with your estate plan, perhaps creating a trust to hold assets for your children and naming that trust as your beneficiary.
Your Beneficiary Designations Should Be Periodically Reviewed and Updated
Just as your estate plan must be periodically reviewed and updated, your beneficiary designations must be reviewed and updated when your life circumstances change over time. We recommend a review of your beneficiary designations every few years, or whenever a major life event occurs, such as a birth, a death, marriage or divorce, relocation or a change of employment.
The Big Picture
Beneficiary designations must be considered as part of the “big picture” of your overall estate plan. Each individual person has unique circumstances and no one particular strategy will fit everyone. You should carefully review your beneficiary designations on your financial accounts to ensure that your beneficiaries coordinate with your goals and estate planning. By doing so, you can avoid potential problems with your assets and your estate after your death.
If you have questions about using beneficiary designations in your estate plan, you should discuss your situation with an experienced estate planning attorney. Please feel free to contact Brian T. Hemphill to schedule a consultation.