Please Keep Your Beneficiary Designations Current At All Times
What is a Beneficiary Designation?
Proper Estate Planning requires the use of legal instruments like wills, trusts, powers of attorney, and advance healthcare directives. But those are rarely ever the only documents in an estate plan. Think about it, we contribute to our retirement plans for our futures, we purchase life insurance to make sure our loved ones are provided if we no longer can, we set up health savings accounts for our medical expenses. These financial assets are an important investment you make throughout your life and they can be transferred through means other than a trust or a will. So, a comprehensive estate plan not only includes legal documents, but also considers other methods of asset transfer as well.
For example, many financial assets are transferred via beneficiary designation. A beneficiary designation is a clause that allows the owner of an asset to determine who will receive the asset upon their death. Put another way, the owner is choosing (i.e. designating) who will receive the asset when the owner dies (i.e. the beneficiary). Commonly owned financial assets with beneficiary designations include life insurance policies, retirement plans (i.e. 401(k) plan, individual retirement accounts, and 403(b) plans.) If used correctly, Beneficiary Designations are a good estate planning tool: they avoid probate and its associated costs, they can be updated with relative ease, and they don’t give the beneficiary any control over the asset while the owner is alive. Beneficiary designations avoid probate because they are technically contracts. The exact terms will vary depending on the financial asset and company offering the asset, but because the agreement to transfer the asset at the death of the owner was made before the owner’s death, those contract terms control the distribution instead of the will, trust, or your state’s probate code.
Common Elements of Beneficiary Designations
While there is no standardized form for a beneficiary designation, there are aspects that are common to all of them. After all, the goals of a beneficiary designation are still the same no matter what company issues the form. When completing a beneficiary designation, you can choose the order in which the distribution will be made. This choice is made by selecting Primary Beneficiaries and Contingent Beneficiaries, sometimes also called Secondary Beneficiaries. Whoever you name the Primary Beneficiary on your beneficiary designation will be the first in line to receive the asset or distribution. If for some reason the Primary Beneficiary cannot receive the asset or distribution, then the Contingent Beneficiary will receive it instead. Your Primary and Contingent Beneficiaries can be your spouse, partner, children, other family members, friends, trusts, charities or your estate, among others. You may receive the option to have multiple beneficiaries at each level. For example, you may be able to name two people as your Primary Beneficiaries and one person as Contingent Beneficiary. If you name multiple beneficiaries at one level, you may be able to decide what fraction or percentage of the asset or distribution they should each receive. If you have the option to list multiple beneficiaries, you may also have the option to make those distribution per stirpes or per capita. A per stripes distribution allows your beneficiaries’ descendants to claim their share if your named beneficiary cannot.A per capita distribution is made to all living beneficiaries listed in the first level of distribution in which there is a living beneficiary.
Per Stirpes, Per Capita, & the Default Beneficiary
Per Stirpes Distribution
An example to illustrate a per stirpes distribution: Let’s say you have two adult children named Adam and Barry. Adam and Barry are listed as the Primary Beneficiaries of your life insurance policy. Adam and Barry will each receive half (50%) of the life insurance payout. You do not list a Contingent Beneficiary. Adam has no children, but Barry has two, Chloe and Doug, they are your grandchildren. Unfortunately, you and Barry unexpectedly pass away in a car accident. Because you have died, your life insurance policy will now pay out. If you chose a per stirpes distribution, the life insurance payout will be half (50%) to Adam, a quarter (25%) to Chloe, and a quarter (25%) to Doug. This is because Chloe and Doug, as Barry’s descendants, get to stand in Barry’s place as a Primary Beneficiary, receive his share of the distribution, and split the payout between them.
Per Capita Distribution
Let’s see how the same example plays out in a per capita distribution scenario. So, you have two adult children named Adam and Barry. Adam and Barry are listed as the Primary Beneficiaries of your life insurance policy. Adam and Barry will each receive half (50%) of the life insurance payout. You do not list a Contingent Beneficiary. Adam has no children, but Barry has two, Chloe and Doug, they are your grandchildren. Unfortunately, you and Barry unexpectedly pass away in a car accident. Because you have died, your life insurance policy will now pay out. If you chose a per capita distribution, the life insurance payout will be completely (100%) to Adam, with nothing (0%) to Chloe, and nothing (0%) to Doug. This is because a per capita distribution will payout and be distributed between the living beneficiaries at the first level in which there is a living beneficiary. Since Adam is a Primary Beneficiary and is the only living Primary Beneficiary on your life insurance policy, he will receive the entire payout.
The Default Beneficiary
If you don’t name beneficiaries at all, the assets will be distributed to the default beneficiary. In most cases, the default beneficiary is your estate. This means the asset is going to probate court which defeats the purpose of having a beneficiary designation in the first place.
Three Common Beneficiary Designation Mistakes & How to Avoid Them
As we’ve covered here, beneficiary designations are useful tools in an estate planner’s toolbox, but don’t be fooled, they are surprisingly complex and can have catastrophic consequences if not done correctly. Here are three common mistakes made on Beneficiary Designations and how to avoid them:
1. Failing to Name a Beneficiary At All
That’s right, many people don’t name any beneficiaries on their financial assets at all. This means those assets are headed to probate court when the owner dies. Your assets can end up in court for months or even years as the proceedings wrap up and the judge may distribute the assets in a way that goes against your wishes. To avoid this be sure to name at least one adult as a primary beneficiary, but ideally, you’d name a fully funded and personalized trust as the beneficiary.
2. Forgetting to Update Beneficiaries
As your life changes, so should your estate plan, including your beneficiary designations. In general, you should review your estate plan every three to five years; or immediately upon the occurrence of a major life event, like a marriage, divorce, birth or adoption of a child, a child reaching the age of majority, or death of an immediate family member or beneficiary.
The importance of updating beneficiary designations is best demonstrated by a recent article by the Wall Street Journal covering the legal battle over Jeffery Rolison’s retirement account. In 1987, Jeffery named his girlfriend as the beneficiary of his retirement account with Procter & Gamble. They broke up two years later, but never updated the beneficiary designation. After his death, Jeffery’s brothers discovered the account, which had grown to $1.15 million in value, and challenged the distribution to his ex-girlfriend in federal court. The court sided with Jeffery’s ex-girlfriend. We can’t know for sure, but it’s likely Jeffery would have preferred his brothers get the account.
The best way to keep your beneficiary designations up to date is to incorporate them into the review of your other estate planning documents. Ideally, your lawyer has a three-year estate plan review system in place, like ours does, and your beneficiary designations can be updated then if needed.
3. Naming a Dependent as a Beneficiary
While you can name a dependent, like a minor child, as the beneficiary of your assets, it’s a horrible, inadvisable idea. Under Florida law, a guardian must be appointed to oversee a ward's assets if said ward has assets worth more than $15,000.00. So, if you’ve named your kids as beneficiaries of your financial assets and something happens to you, it’s all but guaranteed they will end up in court. And, even worse, you could end up with a professional guardian overseeing the assets and charging your estate the fee for their services. This could happen even if the other parent is still alive but cannot afford or qualify for a bond or is deemed unsuitable to oversee the assets by the court. Finally, any financial assets would pay out to the beneficiaries when they reach the age of majority with no oversight or control over the funds. How many responsible decisions would you expect an eighteen-year-old with a five million dollars and no guidance to make?
If you’ve named guardians for your children in your will, you might be under the impression that naming that guardian as the Primary Beneficiary to be a better decision. It’s not. If the guardian is named as the Primary Beneficiary, they will receive those funds in their personal capacity and would have no obligation to use them for the benefit of your children.
To make sure your dependents receive the insurance proceeds without involving the court system or other state arms, create a trust and name a trustee to receive the funds and hold or distribute them accordingly.
TealAcre Can Get Everything in Order
Beneficiary Designations, a seemingly simple but surprisingly complex method of transferring assets at death, are a core part of a comprehensive estate plan. If you’d like to make sure you’re avoiding major mistakes and problems for your loved ones, meet with TealAcre today and get the peace of mind that comes with knowing everything was done properly. We can also assist you in creating an estate plan that’s tailored to your unique needs & circumstances and that keeps your loved ones out of court and out of conflict.
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