PROBLEMS WITH DESIGNATING BENEFICIARIES

coryBy Cory Howes

Designating beneficiaries is a common practice for asset distribution, and for good reason. Many of our clients utilize beneficiary designation, as several significant asset types, including life insurance policies, individual retirement accounts, retirement plans, and even bank accounts allow a beneficiary to be named. This is a free service, it’s easy, and when the asset holder dies, they are designed to be paid directly to the people named as beneficiaries outside of the probate process.

But as you may have ascertained with the title of this article, it’s not always that easy. For example, let’s say that your named beneficiary is incapacitated when you die. In all probability, the court will end up taking control of the funds, because financial institutions—banks, brokerages, and life insurance companies—won’t knowingly transfer assets to an incompetent person and may, in fact, insist upon court supervision of the asset transfer and distribution.

If you name a minor beneficiary of your funds, you are likely setting up a court guardianship for the child. As with incapacitated beneficiaries, financial institutions won’t knowingly release funds directly to a minor or pay to another person on a child’s behalf—not even a parent.

Another tricky outcome is naming “your estate” as the beneficiary upon your death. The court, necessarily, must determine who that is, and the funds will have to go through probate and be distributed along with other applicable assets. Moreover, life insurance proceeds and retirement plan benefits left to your estate may subject those funds to your creditors when they otherwise would be free from such claims. In addition, leaving retirement plan assets to an estate can result in severe tax consequences.

Here’s a more obvious circumstance: if you are preceded in death by your beneficiary or you both die at the same time, and you haven’t named a contingent or secondary beneficiary, the proceeds from the asset must still go through probate.

Also, even if the funds are paid to your named beneficiary, there are often unintended outcomes. For instance, there are many people who are unable to handle large sums of money. While this sometimes means they may spend irresponsibly, it can also mean they are easily influenced by others, make bad investment choices, or lose the money outright to a divorcing spouse or creditor. Often, your planning is for naught, as a beneficiary may take a tax-deferred account and immediately “cash out,” wiping out years of asset growth.

So, too, we see that people often name beneficiaries under a pretense or understanding that the funds will be used for a specific purpose, such as leaving money to a sibling to care for parents. Often, the recipient is just too tempted by the immediate wealth to honor the wishes of the deceased.

Ceding your estate planning options to the simple naming of beneficiaries can cause problems for your heirs, and for you, too. If you name a beneficiary who is receiving government benefits (for example, a child or parent who requires special care), you could be jeopardizing their ability to continue to receive these benefits. Also, if you have a larger estate, your beneficiary choices can limit your tax planning options and have serious tax implications for your family moving forward.

One of the more complicated aspects of beneficiary designations is when you leave assets to trust. Especially with retirement plans, if the beneficiary designations are not properly structured with the right language, it can result in unintended consequences and significant tax liability.

This article isn’t intended to scare you away from using beneficiary designations in your estate planning. They are quite useful components of an estate plan, but they cannot take the place of an overall plan.  Naming a trust as beneficiary will generally prevent the problems described above (if done properly). By bringing all of your assets together under one umbrella plan, you can be sure that each beneficiary will receive the amount you desire, which can be quite difficult to accomplish without properly coordinating your beneficiary designations with your overall estate plan.

If you have questions about the beneficiaries of your estate, email me at the Forrest Firm today. It’s important to know all of your designations. If you can make corrections to these designations in ways that align you’re your overall plan, you can prevent significant problems in the future for you and your family.