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  • Writer's pictureDavid Krueger

4 MISTAKES TO AVOID WHEN NAMING BENEFICIARIES



Even in situations where someone takes the time, effort and expense to have an attorney draft up a will or trust, often reviewing or updating beneficiary designations is not made a priority or completely overlooked.  However, not understanding how beneficiary designations affect your estate plan, or not realizing the consequences of naming certain beneficiaries, could result in significant family conflict and unintentional shifts in the overall distribution of your estate assets. 

 

Mistake One:  Beneficiary Designations that Override Your Estate Documents

 

One of the primary purposes of your Last Will and Testament or Family Trust is to inform the probate court, family members and beneficiaries of your intentions as to the final distribution of your assets.  Beneficiary designations take precedence over your primary estate plan documents, making the provisions you have carefully drafted into your will or family trust irrelevant for the distribution of beneficiary designated assets.

 

For example, assume you have a son and a daughter that you plan to leave your estate to equally.  However, when you opened your primary bank account you only named your daughter as the POD (Pay On Death) beneficiary.  You now sign a new will that states that you want all of your assets to be “divided equally between my children”.  

 

Because you have not reviewed (or even remember) the exact beneficiary designations you made when you opened your bank account years ago, you believe that the recent update to your will “completes” you overall plan to divide all of your assets equally between your two children.  As mentioned above, because beneficiary designations have priority over the distribution provisions of your will, all $200,000 will be distributed to your daughter and your son will receive none of the bank account funds.  You now have a situation where each child is not treated equally upon your death, possibly creating conflict between your children.

 

Most estate planning attorneys state that they are in the “document drafting business” and not in the “coordinating account beneficiaries business”.  They also want to avoid being sued by unhappy children or other beneficiaries that are “surprised” when various assets pass outside the will or family trust pursuant to beneficiary designations.  Therefore, attorneys often specify in their engagement letter that you or your financial advisor (and not the attorney) are ultimately responsible for reviewing and updating beneficiary designations.

 

A comprehensive, well-implemented estate plan will not only consider the distribution provisions in your will or trust, but will make sure assets with beneficiary designations are coordinate with your will or trust to the intended beneficiaries in the correct amounts.  


Mistake Two:  Naming a Beneficiary with Special Needs


In an estate planning context, an individual with “special needs” generally refers to a person who receives (or qualifies for) government aid for a disability.  Most “special need” aid programs are designed to only assist persons having a limited amount of assets or income.  If an individual has assets or income over the qualifying thresholds, the government expects the individual to “spend down” their assets first before the government provides any benefits.

The primary objective with special needs planning is to make sure a person’s income or assets (or a person’s inherited assets) are not “counted against” the special needs individual in qualifying for government benefits.  Often, the most effective way to accomplish this objective is the use of a “Special Needs Trust” that is designed to “supplement” and not “replace” any government aid or assistance.  With a carefully designed special needs plan, assets in a Special Needs Trust are not considered for qualifying for governmental assistance.

Many special needs programs are specific to a certain type of need or medical situation, and have long waiting lists or are difficult to secure.  Being disqualified because of inadvertent beneficiary designations can be devastating to receiving vital aid services.  In addition,  an unexpected disqualification often result in the special needs individual having to reapply or “go to the back of the line” for such governmental assistance programs.


Mistake Three:  Naming Minor Children as Beneficiaries of a Life Insurance Policy


If you name your child as a beneficiary to your life insurance policy, and your child is a minor when you die, the court will appoint a property guardian to manage these funds until your child reaches the legal age of an adult.  Such guardianships require various court appearances and filings with the court on an ongoing basis.  The benefit of the guardianship system is that there is court supervision, which is designed to require accountability by the appointed guardian to minimize the likelihood of inappropriate spending.  While court supervision has some benefits, it also has the drawback of various costs, which are usually paid from the guardianship account funds.


You should also keep in mind that under Kansas law a guardianship for a minor is terminated when the children reaches 18 years of age.  Therefore, at age 18 the court will require that all of the remaining life insurance funds are turned over directly to your child.  Knowing your child, are you confident that he or she could properly handle or manage being given a check at the age of 18 of several hundred thousand dollars or more?   

 

If you want to avoid the hassle of the court involvement and the expense of the required guardianship hearings and filings, you may want to consider one of the following options.

 

1.      Use a living trust.  If you name a living trust as the beneficiary of your life insurance policy, your designated trustee will manage the life insurance proceeds on behalf of your child.  You can then include various other provisions or directions as to your wishes for items such as funding higher education or the designated age for giving your child unrestricted access to the life insurance funds.

 

2.     Name a trusted adult instead.  You can name a trusted adult to be the beneficiary of your life insurance policy who you are confident will use the money for your child’s benefit.  However, this option is not as reliable as using a living trust, unless you are confident that this individual will “do the right thing” without the legal responsibilities and accountability of being a trustee.

 

3.     Utilize a UTMA/UGMA.  The UGMA (Uniform Gift to Minors Act) and UTMA (Uniform Transfer to Minors Act) are nothing more than custodial accounts, which are used to hold and protect assets for minors until they reach the age of majority in Kansas. These accounts typically allow stock, bond, and mutual fund investments, but not higher-risk investments like stock options or buying on margin

 

Mistake Four:  Naming Your Estate as Beneficiary


An “estate” generally refers to your probate estate, meaning assets that are subject to probate. So if you list your estate as the beneficiary of a life insurance policy, then those proceeds will need to be probated after your death.

Designating your estate as beneficiary can have even greater consequences when dealing with retirement assets such as an Individual Retirement Account (IRA).

In situations where an estate is named as a beneficiary of an IRA, there are only two distribution options:

1.    Lump sum distribution.  Option one for distributions when an estate is named as a beneficiary of an IRA is a single, lump sum payment, which is fully taxable in the year of distribution.

2.    Full distribution within 5 years.  Option two would allow the IRA custodian to make a series of distributions to the estate, as long as all of the IRA funds are distributed within 5 years of the decedent’s death.  Each payment is then taxable when distributed.

Estate planners generally agree that of all the IRA beneficiary options, naming an estate as beneficiary is the least favorable option for any level of continued tax deferral of IRA funds.

 

Summary

 

Beneficiary designations are an excellent way to avoid probate.  However, because beneficiary designations supersede the provisions of a will or family trust, failing to review and update your beneficiary designations can result in assets “passing outside” the carefully drafted distribution provisions of your will or trust.  This may result in unintended “shifts” of your assets at death that result in certain beneficiaries receive more or less of your estate than you intended. 

 

Always be sure to ask your estate planning attorney specific questions regarding who is responsible for coordinating beneficiary designations with your estate plan documents.  Consider using another professional, if the attorney is hesitant to become involved, provide clear instructions or take responsibility for ensuring that beneficiary designations are reviewed and updated as part of the estate planning process. 



PLEASE CONTACT US IF YOU HAVE QUESTIONS REGARDING COORDINATING BENEFICIARY DESIGNATIONS WITH YOUR ESTATE PLAN. 

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