Assets Not Controlled by a Will, Part 1: Beneficiary Designations
Estate planning attorneys are always talking about wills and why it’s so important to have one. It may come as a surprise, then, to learn that a will might not be able to control the disposition of all of a person’s property. Certain (potentially high-value) assets such as life insurance policies, annuities, and retirement accounts pass not according to the terms of a will, but as directed by beneficiary designations associated with the policies or accounts. While that may sound like cause for concern, these assets actually present a number of opportunities for estate planners to take advantage of. Still, it’s a good idea to periodically review beneficiary designations to make certain that death benefits will pass as intended. In this blog post, I’ll discuss some of the upsides and pitfalls associated with beneficiary designations. If you’d like to discuss your own beneficiary designations and how they fit in with your overall estate plan, I invite you to get in touch to discuss this topic and more during a free consultation.
Whenever a person opens a retirement account or purchases a life insurance policy, they’re asked to name beneficiaries who will receive the balance of the account or the death benefit under the policy after the account/policy owner passes away. Typically, the account/policy owner names a primary beneficiary and a secondary beneficiary who will take in the event the primary beneficiary predeceases the account/policy owner. It’s possible to name more than one person as primary and/or secondary beneficiary by saying, for example, “50% to Person A and 50% to Person B.” When the account/policy owner dies, the beneficiaries receive their payouts without the funds having to go through probate. This is a huge positive, as it means the assets can be enjoyed by the beneficiaries almost immediately rather than at the end of the lengthy estate administration process.
The downside is, of course, what I mentioned earlier – that the beneficiary designation is what controls the distribution of the asset, not a will. I call this a downside because so many people either mistakenly assume that a will can override the various beneficiary designations they’ve executed in the past or they forget about their beneficiary designations altogether. Meanwhile, events may be transpiring which can impact the ignored or forgotten beneficiary designations in significant ways: named beneficiaries may die, relationships may end and new ones may begin, and children may be born. If an account/policy owner does not change their beneficiary designations, it will be assumed that the owner meant to leave them as they were. The law does not step in and attempt to do things the account/policy owner left undone. Thus, if beneficiary designations aren’t reviewed often and updated as needed, the result may be accounts/policies paying out to beneficiaries who the account/policy owner no longer intends to benefit. Let’s look at some examples to illustrate how this might play out.
Example 1: Frank bought life insurance many years ago. At that time, he was married to Donna, who he named as his primary beneficiary. Sometime later, Frank and Donna divorced. If Frank dies without updating the beneficiary designation on his life insurance policy, and if Donna outlives him, Donna will still receive the death benefit. That’s because divorce does not automatically remove a former spouse from beneficiary designations! Even if Frank were to get remarried, and even if he executed a new will that says “I leave everything I own to my new wife,” the life insurance proceeds would go to Donna upon Frank’s death (provided she outlived him). To prevent Donna from receiving the death benefit, Frank must update his beneficiary designation to remove Donna.
Example 2: Jessica gets a new job and enrolls in her company’s 401(k) plan. She names her husband as the primary beneficiary and names her only child, Stephen, as the secondary beneficiary (assume she does this by naming Stephen specifically rather using open ended language such as “my children”). Jessica and her husband go on to have two more children before Jessica’s husband passes away. If Jessica dies without updating her beneficiary designation, the assets remaining in her 401(k) at her death will go to Stephen to the exclusion of her other two children! Jessica could update her beneficiary designation to direct the assets to her three children in equal shares, but the law will not step in and assume that this is what she would have wanted.
Another thing to note: beneficiary designations play an important role in estate plans that include trusts. Rather than name individuals as the beneficiaries of accounts/policies, it’s possible to instead name trusts as the beneficiaries of these accounts/policies. These trusts can then use the proceeds from the accounts/policies to provide for the needs of the trust beneficiaries. There are a number of reasons why an estate plan would be set up this way, such as to allow funds to be managed on behalf of a beneficiary who is not yet mature enough to receive assets outright. However, this sort of planning provides yet another reason to review and update existing beneficiary designations. Consider one final example:
Example 3: Doug has two children, ages 5 and 7. Doug’s wife (his primary beneficiary) has passed away, and his beneficiary designations on his retirement accounts and life insurance policies name his children as secondary beneficiaries. Doug’s estate plan says that upon Doug’s death, his assets will be held in separate trusts for each of his children and a trustee will have the ability to make distributions to each child as the trustee sees fit. When a child reaches twenty-five years of age, that child’s trust will terminate and the child will receive the balance of the trust property outright. Doug can revise his beneficiary designations to name these two trusts as the beneficiaries of his accounts/policies rather than his two young children directly. This will allow the death benefits of these accounts/policies to be added to the trusts where they can be managed by the trustee and used to provide for the young children. If Doug does not update his beneficiary designations in this way and dies while the children are still young, someone will have to qualify as guardian in order to receive the funds on behalf the children, and the children will ultimately get control of the funds at age eighteen instead of age twenty-five as Doug intended.
One last note: a well written beneficiary designation has to consider more than just the identity of the beneficiaries, but also the tax consequences that will follow from the designation. Retirement accounts and annuities can be tricky to deal with from an income tax perspective, and that is especially true when trusts are involved. An estate planning attorney can help you set up beneficiary designations that best represent your wishes while also keeping your overall plan as tax efficient as possible.
Beneficiary designations are an important though often overlooked part of an estate plan. Fortunately, reviewing and updating your beneficiary designations is easy to do. For accounts and policies offered through your place of employment, your company’s human resources department can help you access your existing beneficiary designations and complete the forms necessary to make changes. For IRAs, annuities, and life insurance not purchased through your employer, the process is similar, but you’ll work with the financial institution or broker in charge of the account/policy directly to make any changes. Most of the information you’ll need can be accessed on the institution/broker’s website, but to effect any desired changes, you will likely be required to sign and mail a notarized beneficiary change form to the institution/broker.
If you would like to discuss the role your beneficiary designations can play in your overall estate plan, please consider reaching out. Initial consultations are always free, and estate planning services provided by The Law Office of Ryan A. Layton, PLLC include the drafting of new beneficiary designation language meant to synergize your designations with your broader estate plan.
The information contained in this blog post is intended only as general legal information and should not be construed as formal legal advice on any matter, nor should its presentation be construed as intent on the part of The Law Office of Ryan A. Layton, PLLC to form an attorney-client relationship with any user of this website. For more information, please see this disclaimer.