Many clients use beneficiary designations, and for good reason. Some significant assets, including life insurance policies, IRAs, retirement plans and even bank accounts, allow a beneficiary to be named. It’s free, it’s easy, and, when the owner dies, these assets are designed to be paid directly to the individual(s) named as beneficiary, outside of probate.
But that is not always what happens. For example:
- If your beneficiary is incapacitated when you die, the court will probably have to take control of the funds. That’s because most life insurance companies and other financial institutions will not knowingly pay to an incompetent person; they may insist on court supervision.
- If you name a minor as a beneficiary, you are probably setting up a court guardianship for the child. Life insurance companies and other financial institutions will not knowingly pay these funds directly to a minor, nor will they pay to another person for the child, not even to a parent. They do not want the potential liability and will usually require proof of a court-supervised guardianship.
- If you name “my estate” as beneficiary, the court will have to determine who that is. The funds will have to go through probate so they can be distributed along with your other assets.
- If your beneficiary dies before you (or you both die at the same time) and you have not named a secondary beneficiary, the proceeds will have to go through probate so they can be distributed with the rest of your assets.
Even if the funds are paid to the named beneficiary, things may not work out as the owner intended. For example:
- Some people just cannot handle large sums of money. They may spend irresponsibly, be influenced by a spouse or friend, make bad investment choices, or lose the money to an ex-spouse or creditor. If the beneficiary receives a tax-deferred account, he/she may decide to “cash out” and negate your careful planning for continued long-term tax-deferred growth.
- If you name someone as a beneficiary with the “understanding” that the funds will be used to care for another or will be “held” until a later time, you have no guarantee that will happen. The money may just be too tempting.
- If the person you name as beneficiary 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.
- If your estate is larger, your choice of beneficiary could limit your tax planning options, causing serious tax consequences for your family.
Beneficiary designations can be quite useful, but they need to be considered as part of an overall estate plan. Naming a trust as beneficiary will generally prevent the problems described above, and by bringing all of the client’s assets together under one plan, you can be sure that each beneficiary will receive the amount the client wants them to have—something that can be difficult to accomplish with multiple designations.
Making a Retirement Plan Trust a designated beneficiary of a tax deferred retirement plan is an excellent choice to insure the beneficiaries (usually children) will not cash out the benefits and destroy the huge benefit of tax deferred growth and to acquire asset protection for the beneficiary in an accumulation trust.
When meeting with a potential client, or reviewing a client’s existing plan, it is important for the estate planning professional to see all beneficiary designations. Correcting any designations now, and making sure the client understands them, will help to prevent significant future problems.