April 23, 2012   Estate Planning

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 you have named as beneficiary.

But that is not always what happens. For example:

  • If your beneficiary is incapacitated when you die, the court will probably have to take control of the funds. That’s 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, you are probably setting up a court guardianship for the child. 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.
  • And 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 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 from you, he/she 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.
  • If the person you name as beneficiary is receiving government benefits (for example, a child or parent who requires special care), you could be jeopardizing their ability to continue to receive these benefits.
  • 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 the way you want. 

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