The Surprising Importance of Proper Beneficiary Designations
By Jeff Moore
Most of us have some form of a “beneficiary-designation asset,” such as a life insurance policy, an Individual Retirement Account (IRA), a 401(k) or other retirement account, an annuity contract, or any other type of asset that permits the naming of a beneficiary to receive the proceeds or benefits upon one’s death. But do you know who your beneficiary is on such an asset? Are you sure? Have you recently confirmed the designation with the custodian or financial institution? All too often our clients discover that what they thought was the case may not be reality after all. But even if the belief is confirmed as reality (whew!), the current beneficiary designation may not be the ideal designation for estate or tax-planning purposes (huh?). The unintended results may surprise you.
For starters, consider a common divorce situation. The final divorce decree allowed you to retain, in full or in part, your individual retirement account. The decree further authorized you to remove your former spouse as the primary beneficiary in favor of your children (or any other beneficiary). Everything is set then, right? Not so. Just because the court decree authorized the change in the beneficiary designation, it does not mean that the beneficiary designation has actually changed. If no action is taken on your part to effectuate the change, it is possible that your former spouse could still be named as the primary beneficiary of the account benefits. Is that your intent? Most likely not. You need to update the “Change of Beneficiary Form” to reflect your current wishes.
Minor or Incapacitated Children
So let’s continue with the divorce example above. You move forward with changing your primary beneficiary from your former spouse to your children equally. Each child will receive their fair share. You think nothing more of it. But if your children are minors they cannot inherit the benefits until they reach the age of majority. So now what? Because the children are minors, a court proceeding must be initiated to appoint a Conservator for your minor child. The initial process and appointment itself is cumbersome and expensive, but it doesn’t end there because the Conservator must complete an annual report for the court as to the management and use of the funds. This annual reporting continues until the child reaches the age of 18. But for some clients, the fact that their child will receive all of the proceeds upon turning age 18 is the most concerning issue of all. Not only is there the concern of the child’s own fiscal and emotional maturity at age 18, there is the concern of undue influence on the child by others.
The same issue is true for an incapacitated child despite the fact that such child is older than age 18. If the child does not have sufficient capacity to manage their own assets, it is possible that the Conservatorship for the child must continue for the life of the child or at least until the incapacitating condition terminates. In some cases, naming an incapacitated child as the direct beneficiary may actually disqualify the child from various government benefits such as supplemental security income.
Doesn’t My Will Control?
Contrary to common belief, the provisions of your Will do not control the proceeds or benefits of your beneficiary-designation assets. The beneficiary designation on the contract will control who receives the benefits. Accordingly, simply because you named “my spouse and then my children” as the beneficiaries under your Will, it does not change the fact that you named your parents as beneficiaries under your life insurance policy long before your marriage and the arrival of your children.
On the other hand, if no beneficiary is named on the beneficiary-designation asset, it is possible that your estate (i.e., your Will—or the one the State writes for you if you failed to do your own) will become the default beneficiary of your assets. But this default designation could have totally unanticipated and surprising results, including a court probate for the benefits and the potential loss of significant income tax deferrals for retirement account benefits. For example, if an IRA account owner names his or her spouse as primary beneficiary and passes away, the surviving spouse can roll over the IRA into his or her own IRA and continue the same income tax deferrals over their own expanded life expectancy. But if the account owner failed to name a beneficiary, or simply designated “my estate”, then the benefits may all be distributed within five years of death and the continued income tax deferrals lost.
Coordinating Your Beneficiary Designation with Your Estate Plan
If your estate plan is simply “my spouse then my children equally” then naming your spouse as the primary beneficiary and your children as the contingent beneficiaries may be a perfectly viable solution (or any other beneficiary designation that matches your distribution intentions). However, make sure that your intentions are what the contract designation provides. In addition, many contracts have a primary beneficiary named, but too often fail to name any contingent beneficiaries.
Furthermore, if you have implemented a Living Trust or an estate plan that includes estate-tax planning strategies such as a Bypass or QTIP Trust, and perhaps lifetime or age-limited trusts for children, then simply naming “spouse then children” or any other generic designation will not produce the desired results. For example, the Living Trust is typically named as the primary beneficiary of a life insurance policy. In cases where there are ongoing trusts for children, the Trustee of the separate trust share for a child is typically named as the beneficiary for any retirement or annuity benefits—not the child directly.
It is critically important to confirm your beneficiaries on beneficiary-designation assets. Determine if the current contract matches your current objectives. If not, we can help you update the beneficiary designations to match your estate and tax-planning strategies . . . and eliminate any undesirable surprises.