Beneficiary Designation Planning: Not As Simple As You Think

Accountancy Resources

Beneficiary Designation Planning: Not As Simple As You Think

Retirement Author: Admin


Most of us are familiar with the term beneficiary designation, and while the obvious choices such as your spouse, children, or parents come to mind, they may not be the most appropriate choices. Often, beneficiary designations are not updated or coordinated with an estate plan, especially in wills and trusts, and after mistakes are made, your heirs may have to live with them. If you have a life insurance policy, an IRA, a 401(k) plan, a 457 plan, a 403(b) plan, or an annuity, then you were required to name a primary and contingent beneficiary because these types of investments pass outside of your will. Failure to name a beneficiary causes proceeds to be paid to the account owner’s estate, often causing excessive income tax or exposing those assets to the claims of creditors.

Listed below are other pitfalls that should be noted when planning the distribution of your estate:

Naming a Minor the Beneficiary

Many people name minor children as primary or contingent beneficiaries – a logical but often an unwise choice. Since a minor cannot legally receive funds directly, a probate judge would need to appoint a guardian or conservator of the minor and release the funds to this person or entity. This is a process that requires getting authorization from the court and therefore may result in added expenses. There is, however, an alternative: Specifically, the Uniform Gifts to Minors Act (UGMA) or the Uniform Transfers to Minors Act (UTMA) create custodianships which are generally recognized in state law as “trustee-like,”? acting on behalf of a minor under the state laws prescribed. If one or more of the beneficiaries in your will is a minor, the custodian you appoint may establish a UGMA or UTMA account for each minor. Like a trustee, the UGMA/UTMA custodian will be charged with administering the funds for the benefit of your children.

No Contingent Beneficiary

Most people designate only a primary beneficiary, not realizing that if the primary beneficiary dies before they do and they fail to name a new primary beneficiary, the proceeds are paid to the decedent’s estate and potentially subjecting those assets to estate taxes and creditor claims.

Estate Tax Conflicts

You leave your $2 million life insurance to your daughter of the first marriage and the rest of your estate to your children of the second marriage. Your will states that taxes are to be paid out of the residuary estate thereby forcing the children of the second marriage to pay the estate tax on the life insurance proceeds left to the daughter of your first marriage.

Does federal or state law control the beneficiary designation? Under the Employee Retirement Income Security Act (ERISA), if you are married and name someone other than your spouse as a beneficiary of a group life insurance policy or company-sponsored retirement plan, you must have spousal consent in writing or the proceeds will be paid directly to the spouse.

Beneficiary Coordination

In many cases, individuals have well-planned wills and trusts, but fail to coordinate the beneficiary designations of their life insurance and retirement plans with their estate plans. The same holds true if you divorce and forget to change your beneficiary designation. Most states have provisions that protect your heirs from this circumstance, but it can create unreasonable delays in settling an estate.

While these are just a few of the considerations that must be taken into account when naming beneficiaries, you should review all the beneficiary designations on all of your investments and insurance policies and consult with a professional to avoid all unnecessary taxes and settlement costs.