Beneficiary Designations: Simple but Not Always Effective

Many people use beneficiary designations, and for good reason. Some significant assets, including life insurance policies, IRAs, retirement plans and even bank accounts, allow you to name a beneficiary. When you die, these assets are designed to be paid directly to the individuals, trusts, and charities you have named as beneficiary. As the following examples demonstrate, however, that is not always what happens:

• If your beneficiary is incapacitated when you die, the court will probably have to take control of the funds. That is because most life insurance companies and other financial institutions will not knowingly pay to an incompetent person; they may insist on court supervision.
• If you name a minor as a beneficiary, the court will need to appoint a guardian to receive and hold the money on behalf of the child and to represent the child’s interests when dealing with the institutions holding the money. Life insurance companies and other financial institutions will not knowingly pay these funds directly to a minor, nor will they pay to another person for the child, not even to a parent. They do not want the potential liability and will usually require proof of a court-supervised guardianship.
• If you name “my estate” as beneficiary, the court will have to determine who that is. The funds will have to go through probate so they can be distributed along with your other assets.
• If your beneficiary dies before you (or you both die at the same time), and you have not named a secondary beneficiary, the proceeds will pass according to the default terms of the beneficiary designation forms. If the default terms leave the proceeds to your estate, then they will have to go through probate so they can be distributed with the rest of your assets.

Even if the funds are paid to the beneficiary you have named, things may not work out as you intended. For example:

• Some people just cannot handle large sums of money. They may spend irresponsibly, be influenced by a spouse or friend, make bad investment choices, or lose the money to an ex-spouse or creditor. If the beneficiary receives a tax-deferred account such as an individual retirement account from you, the beneficiary may decide to cash out and negate your careful planning for continued long-term tax-deferred growth.
• If you name someone as a beneficiary with the understanding that the funds will be used to care for another or will be held until a later time, you have no guarantee that will happen. The money may just be too tempting. Furthermore, if the beneficiary does follow your wishes, the beneficiary would potentially need to use a portion of the beneficiary’s estate and gift tax exemption amount when making distributions to the intended final recipient.
• If the person you name as beneficiary is receiving government benefits (for example, a child or parent who requires special care), you could jeopardize your beneficiary’s ability to continue to receive these benefits. In order for an individual to receive special needs benefits from the government, the individual must not exceed a government determined limit on income and owned property.
• If your estate is larger, your choice of beneficiary could limit your tax planning options, causing serious tax consequences for your family.

The solution: Beneficiary designations can be quite useful, but they need to be considered as part of your overall estate plan. Naming a trust as beneficiary will often prevent the problems described above, and by bringing all of your assets together under one plan, you can be sure that each beneficiary will receive the amount you want them to have—something that can be difficult to accomplish with multiple designations. An experienced estate planning attorney will be able to provide valuable guidance and make sure your plan will work as you intend it to.