The Importance of Beneficiary Designations in Estate Planning
by Kevin DeYoung, CPA, AEP
Many individuals focus their estate planning efforts on crafting a Last Will & Testament or Revocable Living Trust that directs how their assets are to be distributed at the end of their life. But many individuals also fail to recognize the importance of beneficiary designations and understanding that certain assets transfer to designated beneficiaries regardless of what other estate planning documents (such as a Will or Trust) might say. This has the potential to create confusion and unintended consequences, which is precisely what great planning is meant to avoid.
Common examples of assets that transfer at death via a beneficiary designation include:
- life insurance death benefit proceeds
- IRA & 401(k) accounts, annuities
- cash or investment accounts titled as a transfer/payable on death (TOD/POD) account, or
- real estate titled with a transfer on death (TOD) provision.
Here are two common mistakes made that can be avoided if greater care is taken when updating your estate plan.
Estate planning documents disburse assets differently at death than an asset or account with a beneficiary designation.
A classic example is a parent that makes changes to their estate planning documents to disinherit one of their children and/or reduce one child’s share of the inheritance to a lesser percentage than their siblings, yet fails to update the beneficiary designation on their life insurance policy or IRA account to mirror that decision. A child receiving nothing under the parent’s Will or Trust, but an equal share of an IRA account was probably an unintended result and sends mixed messages to the family. Did the parent intend for that child to get an equivalent amount of the IRA or not? No one really knows for sure, as the parent who made the decision is now deceased.
Another similar situation is when a parent is concerned a child might spend all of their inheritance at once, so they leave that child’s share “in trust” to receive the inheritance over time, yet that child’s share of a life insurance policy goes entirely to them at once via a beneficiary designation that doesn’t reference any sort of “trust”. This creates confusion for the child on what the parent really intended to happen.
A married couple’s estate tax minimization planning efforts are undermined by assets designated to pass to the surviving spouse.
Let’s assume that in order to take advantage of an estate tax exemption, a married couple’s Will or Trust funds a bypass trust or credit shelter trust upon the death of the first spouse. Unfortunately, in an attempt to make the transfer of assets simpler and quicker, they had many of their joint assets set up in a way to automatically transfer directly to the surviving spouse. By having these assets transfer via beneficiary designations, there were not enough other assets passing under the terms of the Will to fully fund the bypass trust that was to be created, and so the estate tax exemption could be wasted. Thus, they inadvertently created a higher estate tax burden in the estate of the surviving spouse.
The overall message here is not that assets passing via beneficiary designations at death are a bad thing. In many cases, these assets transferring under beneficiary designations can be desired and happen seamlessly without probate proceedings or delays. That being said, when you are updating your estate plan you should always make sure that accounts with beneficiary designations are consistent with your other estate planning documents and don’t undermine great estate tax planning steps.
If you need help evaluating proper beneficiary designations on your accounts, you should always reach out to your CPA to discuss these important matters.
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Kevin DeYoung, CPA, AEP
Kevin joined Larson Gross in 1994. Today, he is a Partner and the Individuals & Family Wealth practice area leader. He specializes in Estate Planning and Estate, Trust, and Gift Tax.