Grace was so happy - her granddaughter, Sarah, had gotten married! The last time I had seen her this happy was when Sarah graduated college.
Being a financial planner, I felt I had to tell her, “Make sure she and her husband update their beneficiary designations.”
“Oh,” Grace said, “they told me they updated their Wills.”
The financial planner in me continued, “If they do not change their beneficiary designation on their retirement accounts, life insurances, and annuities, the surviving spouse could get nothing.”
Grace was surprised and had questions. We discussed the necessary updates her granddaughter and new husband would need to make so assets pass as they wish.
Painting a picture for clients that highlights unintended consequences is one of the duties of a Wealth Manager. Knowing the purpose of Wills and Beneficiary Designations will prevent unintended consequences.
Using a Will as a basis of your estate plan is essential because it provides direction to others after your death and typically states:
- Who will serve as the personal representative of your estate? This is the person that will settle your estate after you pass.
- The Will delineates the power your personal representative will have and their responsibilities.
- It defines who and when your assets will be transferred to heirs.
- It lists who will be the guardian of minor children.
Beneficiary Designations are Will Substitutes and are not governed by the provisions of your Last Will and Testament. Whether or not you have a Will, Beneficiary Designations, allow for an orderly and timely transfer of assets.
You should complete primary and contingent (secondary) beneficiary designations on your retirement accounts, such as: 401(k), 403(b), 457, Federal Thrift Savings plan, SEP-IRA, SIMPLE IRA, Keogh, and IRA. Beneficiary designations are also requested on life insurance policies and annuity contracts.
When you pass away, the person(s) or entity you list as primary beneficiary will receive the asset. If, the primary beneficiary dies before you pass, the contingent (secondary) beneficiary receives the asset.
When is a good time to review your beneficiary designation? Two big ones: death of one of the listed primary or contingent beneficiaries or divorce - listing an ex-spouse as beneficiary gets overlooked often. Periodically review your beneficiaries to assure that your assets flow to the intended recipient(s) at you pass.
I entered the extensive FAI Archives and dug out this nugget on Beneficiary Designations:
Beneficiary Designation: Dos and Do Nots
DO NOT Name Minors as Beneficiaries: If you leave assets to a minor, typically a guardian must be appointed by a court to receive and manage the assets until the child turns the age of majority in the state of residence. The legal costs for seeking appointment of a guardian are not insignificant. If you have heirs that are minors, you can set up a trust and designate the trust to receive funds that would otherwise pass to a minor. The terms of your trust will set forth when the beneficiary will have access to their inheritance and, until that time, the funds will be shielded from the beneficiary's creditors and claims of the beneficiary's spouse.
Do NOT Name Your Estate as a Beneficiary: Life insurance proceeds and most retirement accounts are protected from creditor claims after your death. However, if you name your estate as the beneficiary or you do not name a beneficiary, those assets will pass through probate and will become subject to creditor claims against your estate. If you fail to designate a beneficiary, your estate will likely be the beneficiary by default.
DO NOT Assume Your Will or Trust Supersedes your Beneficiary Designations: With only a few exceptions relating to spousal rights, your beneficiary designations on your life insurance and retirement accounts will trump your will or trust.
DO Consult an Attorney or Tax Advisor Before Naming a Trust as the Beneficiary for Retirement Accounts: Special tax rules apply when you name a trust as a beneficiary of your retirement accounts. In most cases, naming your spouse or adult child(ren) as the beneficiary of your qualified retirement plans is recommended so that they can capitalize on income tax advantages by deferring taxes over their lifetime.
DO Name a Secondary (Contingent) Beneficiary: If your primary beneficiary predeceases you or disclaims their interest in the asset, the asset will be distributed to whomever you name as your secondary (or "contingent") beneficiary. It is important to name a back-up beneficiary to avoid having your estate be the default beneficiary as discussed above.
DO Complete a Payable-on-Death Designation ("POD") for Bank Accounts Titled in Your Name Only: An asset with a POD designation will pass to the named beneficiary without going through probate. This is preferable to naming a child as a joint account owner with rights of survivorship because doing so makes your account subject to the child's creditors.
DO Keep Copies of Your Beneficiary Designations in a Safe Place: A fireproof box or home safe is ideal to store your important documents. A safe deposit box can pose problems if no one has access to it after your death. It is a good idea to let the person you named as the executor under your will know where he or she can find copies of your beneficiary designations.
DO Review Your Beneficiary Designations: You should review your beneficiary designations periodically or whenever you have a life change that may impact your beneficiary designations, such as marriage, divorce, or the death of a named beneficiary. Life insurance and retirement accounts often comprise the bulk of a person's estate and forgetting to update your beneficiary designations can lead to unintended and unfortunate consequences.
This blog is part one of a three-part blog series addressing Will Substitutes. Parts 2 & 3 will cover titling of accounts and use of trusts.
If you are interested in learning more about our Investment and Financial Planning services, please contact our office. We look forward to speaking with you and answering your questions.