Top Mistakes in Making Beneficiary Designations

Money Going Down Drain (Because of Mistakes in Making Beneficiary Designations)

How will your assets be transferred to your loved ones after your death? Your first thought may be that your last will and testament will distribute your assets, and this may be true to an extent. Chances are, though, that you have assets that will pass to others because of the beneficiary designations you have made. And without realizing it, you could easily have made mistakes in making beneficiary designations.

Assets owned in your sole name will go through probate, but there are many types of assets that will not. These include assets in a trust; real estate or bank accounts held jointly with another person that have a right of survivorship, meaning that the survivor takes the asset; retirement accounts; life insurance policies; transfer-on-death (TOD) accounts; and payable-on-death accounts. All of these assets may be subject to one or more of the following mistakes. Have you made any of them?

Failing to Name a Beneficiary

What happens if you don't name a beneficiary on a retirement account or life insurance policy? The probable outcome is that the benefits will go through probate when you die. Not only does this create inconvenience, it could, in the case of the retirement account, create avoidable and unnecessary negative tax consequences.

It's also possible that the company holding your policy or account has specified default beneficiaries in the contract. If so, these assets may end up in the hands of people you never intended to have them. Fortunately, there is a simple fix: just fill out the company's beneficiary designation form.

Failing to Name Contingent Beneficiaries

If you have named a beneficiary on your account, congratulations—but what happens if that beneficiary dies before you do? In that case, or in a situation in which you die close in time to one another and you haven't had time to name a new beneficiary, you are back at square one. For this reason, you should always name a contingent beneficiary to take the asset in case your primary beneficiary predeceases you.

Forgetting About Beneficiary Designations You Have Made

If you have named a primary beneficiary and contingent beneficiary on your accounts, don't make the mistake of never revisiting those decisions. Periodically, and especially if you have gone through a life transition like divorce, you should reconsider your beneficiary designations. Imagine this scenario: You are married and name your spouse Lee as the beneficiary. You divorce, and get married to Chris. A few years later, you die without having changed your beneficiary. The company holding the asset may very well transfer it to Lee in accordance with your existing designation. Even if Chris is able to successfully challenge that in court (far from a sure thing), it would be a lengthy and potentially costly legal battle.

Naming a Child as Co-Owner of an Account

As you get older, and your adult children assist you more and more, it may seem sensible to add your child to your bank account or investment account so they can more easily access funds for your benefit. Even if you have the most trustworthy child in the world, this is a bad idea for multiple reasons. No matter the agreement between you and your child about the use of funds, your child now legally owns half of them. This could result in gift tax consequences for you, or mean that your child's creditors can claim against account funds. And while your child may understand your wishes regarding the use of account funds, he or she is under no legal obligation to honor them.

Naming One Child as a Beneficiary of an Account or Life Insurance Policy

It often happens that an older parent comes to rely more on one child than the others, perhaps because they live closer or have more time to help out. If that is your situation, you might have considered naming that child beneficiary on your life insurance policy, with the intention that he or she use the proceeds to pay for your final expenses, then split the rest equally among the siblings.

This is, to put it bluntly, a bad idea. First and foremost, as in the bank account scenario above, the funds would legally belong to the named beneficiary, who would be under no legal obligation to share or use them for any specific purpose. Even if the child does just as you intend, however, the fact that you chose him or her as the beneficiary may cause resentment among the other siblings—a legacy you don't want to leave.

Naming a Minor Child or Person with Special Needs as Beneficiary

If you name your minor child as the direct beneficiary of a life insurance policy, you may not be bypassing the probate court, and you may create unintended problems. Someone will need to be appointed as a guardian to manage the proceeds of a life insurance policy until the child reaches the age of 18. At that time, he or she is a legal adult and will be entitled to the full remaining death benefit of the policy. Most 18 year olds lack the maturity and financial savvy to manage this sudden windfall in a way that will truly benefit them.

Likewise if you intend to benefit a loved one with special needs who receives government benefits like Supplemental Security Income (SSI), please think twice. Naming such a person as direct beneficiary could jeopardize their eligibility for benefits and cause them to have to "spend down" the assets you left them to qualify for benefits again. Instead, consider establishing a special needs trust for their benefit.

Designating an Individual as a Beneficiary on an Account

This one may come as something of a surprise to you, but bear with us. Our attorneys have seen many bankers and financial professionals talk people out of creating trusts because "why pay a lawyer to create a trust when you can simply make a beneficiary designation?"

Unfortunately, though a beneficiary designation may keep assets out of probate, there are still problems if the beneficiary dies before you, or if the beneficiary gets a divorce or has creditor issues. The assets will not be protected from a creditor or spouse. Also, naming an individual as beneficiary does not allow for tax deferral on the benefits as with certain trusts. As noted above, if the beneficiary is a minor, a guardian will need to be appointed to manage the assets, which will likely be more costly than simply establishing the right kind of trust.

Establishing a multigenerational trust can help you make sure that your assets go where you intend them to go, while preventing young beneficiaries from inheriting all assets outright when they reach the age of 18. These trusts can also be designed to protect assets from beneficiaries' creditors. And because the trust is named as the beneficiary on a life insurance policy, bank account, or retirement account, you don't need to worry about being predeceased by a beneficiary. The trust will simply distribute assets to surviving beneficiaries.

If you would like to learn more about how multigenerational trusts can protect you from making common beneficiary designation accounts, we invite you to contact our law firm to discuss your estate planning needs.

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Categories: Estate Planning