Are Your Beneficiary Designations Working Against Your Estate Plan?
Are Your Beneficiary Designations Working Against Your Estate Plan?
One of my pet peeves as a financial advisor is blanket financial advice given to non-specific audiences. This can happen at cocktail parties or family dinners, which is problematic enough, but it’s even more of an issue when it starts being passed around in bulk via chain emails or social media.
At least a few times each year, a client will send me something they’ve seen on social media or received via email regarding how their assets transfer on death.
It’s not that the advice is inherently bad. In the best-case scenarios, the advice itself is well meaning and will work for a lot of people but would also substantially undermine the plans of a few. In the worst-case scenarios, it can be false, misleading, or trying to sell something that’s unnecessary or overly complex. The biggest issue with these types of emails or posts is not whether they are good advice or bad advice, it’s that they’re not universally good advice for everyone.
A common topic of posts like these is naming beneficiaries or transfer on death designations to financial accounts. And I’m a big advocate for naming the right beneficiaries to your financial accounts if it’s appropriate and works with your estate plan. But as a financial advisor who works regularly with estate planning attorneys, both in the creation of estate plans and on the execution of estate plans after a loved one has died, I’d like to say, again and again, it’s not just about designating beneficiaries for your accounts, it’s about making sure they work in conjunction with your estate plan. And when a social media post or a chain email drops into your account with some well-meaning but overly simplistic advice like, “make sure you have a beneficiary on all of your bank accounts” it’s important not to just go off and add or change the beneficiaries on your accounts without making sure you’re not undermining a lot of work that has gone into your current estate plan.
What is a beneficiary designation?
The first thing to understand is that beneficiary, transfer, or pay on death designations are often the easiest way to transfer assets to your heirs after you die, provided they are over the age of 18. Typically, when a person dies and their account has a named beneficiary, the only thing required for that account to move to the beneficiary is a copy of the death certificate and the government issued ID of the beneficiary.
Beneficiary designations take precedence over wills and most trusts. Which is to say, if you have a will or trust set up to distribute your assets in a very specific way, but you’ve named a competing or different interest as a beneficiary, it won’t matter what your will or trust says (or how much you paid an estate planning attorney to create it) the account will go to the named beneficiary.
Contrary to some false information floating around on the internet, beneficiary designations do not allow you to avoid estate and inheritance taxes, though they do, generally allow you to avoid probate.
Your beneficiary designations should work in conjunction with your will and estate planning documents, and often, the more complex these documents are, the more potential there is for your beneficiary designations to actually undermine your comprehensive estate plan.
And yes, it is very important for you to have beneficiary designations (or, if you don’t have them, for that to be an intentional choice, made under the advisement of an estate planning attorney). The key takeaway here is not to not name beneficiaries, it’s to understand how your estate plan works, and to work with the people who developed it to make sure your beneficiary designations are not undermining it.
To further drive this point home, I’d like to look at a few common scenarios where naming the wrong beneficiaries can create unintentionally problematic circumstances after death, then we’ll take a closer look at the right way to review your designations.
Heirs that are under 18
This is, in my experience, one of the most common mistakes people make when they name beneficiaries. If you name a minor or minor(s) as beneficiaries on accounts and you die, it will immediately trigger
1.The need for a custodian (who is subject to regular court oversight) to manage the funds until the child turns 18, and
2. The immediate transfer of the entire account balance, unrestricted, to the child or children, as soon as they turn 18.
Although the situations I’ve most seen this in involve separated parents who have named their minor children as primary beneficiaries, this can also happen in cases where both parents die at the same time and the kids are named as contingent beneficiaries, or in situations where people name nieces or nephews as primary beneficiaries. In general, it is just not a good idea to name minors as beneficiaries on financial accounts.
It’s not that you can’t leave assets to a minor, it’s that doing it through a beneficiary designation is a bad way to do it. At minimum, you should work with an estate planning attorney to get a will in place with a testamentary trust for minor beneficiaries and then make sure you are not undermining that will and trust by naming those children (or anyone else) as beneficiaries on your accounts.
Wills/Trusts Designed for Tax Sheltering Assets
There are a variety of methods using trusts written into wills, particularly between spouses, that are designed to minimize state levied estate and inheritance taxes. And on more than one occasion, I’ve seen these strategies completely decimated by an unchecked or overlooked beneficiary designation.
For example, if your will involves the creation of a disclaimer trust that can be utilized by the primary beneficiary on your accounts to take advantage of tax-free inheritance between spouses, but you’ve also named contingent beneficiaries on your accounts, you’ve basically eliminated the option the surviving spouse has to utilize that disclaimer trust, because those disclaimed assets will, by law, go to the named contingent beneficiaries, not into the disclaimer trust as intended.
If you are working with an estate planning attorney on a strategy like this, pay them for an extra hour of their time and have them review the beneficiaries on all your accounts once your documents are complete to make sure you don’t have something lurking in the background that will undermine the plan you’ve just put so much effort into creating.
Leaving Beneficiaries Blank or Designating Estates or Trusts as Beneficiaries
This is the flip side of the situation above but can also create far more problems than it is intended to. It’s not to say there’s not a place for this, there are specific situations where this is exactly the right thing to do in an estate plan. But just because you have a will, that doesn’t necessarily mean that you don’t want things to pass through beneficiary designations. In fact, many estate plans include a will as a backup and rely on strategic beneficiary designation to accomplish their overall estate planning goals. And, if someone mistakenly believes that they want their will to take precedence, and names their estate as the beneficiary, when in fact their estate planning attorney has designed an estate plan around their beneficiaries being the primary way money moves after death, this can also have a lot of unintended consequences, including but not limited to the forced distribution of taxable funds on an accelerated timeline from IRAs.
What is the Correct Way to Name and Review Beneficiaries?
Ideally, you want to make this a periodic task that you undertake with the help of your financial team. Work with your financial institutions or your financial advisor to compile a complete list of your primary AND contingent beneficiaries and have this reviewed by your estate planning attorney any time there are changes to either your estate planning documents or the beneficiaries you named.
The internet is not wrong about the fact that beneficiary designations are extremely important. But where the internet gets it wrong is by suggesting that it’s an item that you can give as little thought to as naming an emergency contact. It’s not. Naming beneficiaries is one part of a comprehensive estate plan, and it’s extremely important to know how your beneficiaries work with your overall estate plan, and to periodically review them with the attorney who drafted that plan, because naming them incorrectly can have enormous and sometimes financially devastating consequences.
