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The Benefits of Beneficiaries
What is a Beneficiary?
Just like the word suggests, a “beneficiary” is a person or entity receiving the benefit of an asset. A beneficiary can be a spouse, child, grandchild, or really anyone. In addition, a beneficiary does not need to be flesh and blood. For example, your favorite charity can be a
beneficiary. If giving to a charity is a significant part of your estate plan, directing IRA or 401K benefits to the charity makes sense, as they don’t pay income taxes. One beneficiary everyone wants to avoid, however, is the IRS!
How is a Beneficiary Created?
A beneficiary is designated when the person or legal entity is named in a legal document to inherit specific assets or assets, generally upon the owner’s death. These legal documents are commonly a last will and testament or a revocable living trust. Assets can alternatively pass directly independent of any such legal documents. Certain assets pass by contract through beneficiary designations, like those provided for life insurance death benefits or the proceeds from a retirement plan like a 401(k), 403(b), or IRA. The non-probate transfer laws of many states allow assets to pass directly to a beneficiary by a designation applied to the asset itself, whether paid on death or transferred on death. Other assets pass by operation of law to a beneficiary, like when a joint owner of an asset dies and there is a surviving joint owner.
Who Can Be a Beneficiary?
Minors may not be direct beneficiaries. If the intention is to provide financial support for the minor, an “inheritance trust” can be created to administer and distribute trust assets for the minor child’s benefit. The terms of the trust can be tailored to meet the objectives of the trust creator (i.e., owner of the trust assets) and the beneficiary’s needs. Whether the inheritance trust is created under a last will (known as a “testamentary trust) or under a revocable living trust, a trustee will follow the trust instructions and ensure that the terms of the trust are
followed. The terms of payout from the retirement plan to the trust is a very income tax complex decision and should be made and ultimately orchestrated with an estate planning attorney, CPA, and financial advisor.
Every asset passing by the contract should have both a primary and contingent beneficiary. If the primary beneficiary dies before the owner, the contingent beneficiary receives the asset on the owner’s death. Identify beneficiaries clearly, using proper legal names and Social Security numbers. Problems occur when the identity is unclear, for instance, when multiple people in a family have the same or similar names.
Why Updating Beneficiaries is as Important as Updating Estate Plan
When an asset is arranged to pass by contract, operation of law, or by non-probate transfer laws, the beneficiary arrangements supersede the control of the owner’s last will or revocable living trust unless the previous will or revocable living trust is itself the beneficiary. Consequently, when the asset owner fails to update the beneficiary arrangement, unintended consequences follow. This can lead to litigation and even family feuds lasting for generations. Beneficiary arrangements must be updated to avoid this problem, especially when there are births, deaths, marriages, and divorces in the family. What was a correct beneficiary for younger children could be a significant headache for adult children.
What Happens When No Beneficiary is Named?
When an asset has no beneficiary designated or no surviving beneficiary, the asset becomes subject to probate. If there is no last will directing the disposition of any assets subject to probate, then the decedent owner has died intestate. As a result, the probate court applies the state laws of intestate succession to determine the beneficiary or beneficiaries of such assets. These laws apply by default and
presume that people want to leave assets to their relatives based on how closely they are related. However, this is not always what the decedent would have liked.
Suppose no beneficiary is named for a retirement plan or life insurance policy. In that case, the custodian may have a process for assigning a “default” beneficiary, who may not be the person you want.
There may be further tax consequences if no beneficiary is named on tax-deferred retirement accounts.
Family Members with Special Needs Should Not Be Direct Beneficiaries
Means-tested public benefits are subject to strict asset limitations to become or remain eligible. Family members receiving or may become eligible for such uses may not own or have access to assets exceeding those eligibility limits. To preserve access to benefits and to enjoy the benefits of an inheritance, a special needs trust is required to administer the inheritance of the beneficiary with special needs.
The Benefits of Beneficiaries Require Care and Planning
Failing to maintain beneficiary designations is one of the most common and easily avoided errors in estate planning with competent advice. Once an inventory of accounts and assets has been created, an annual update is simple and quick.
We have a Zoom online training session on “Beneficiary Designations for Life Insurance and Retirement Plans” on Monday, June 5, at 6:30 pm. It will cover some basic beneficiary concepts.
To register, you can click here.
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