19 Feb 20210 Comments
When thinking about estate planning, most of us would think first about drafting a last will and testament and perhaps a trust. What is often overlooked as part of the process though is making beneficiary designations.
Beneficiary designations can be a very useful tool in creating your estate plan, but they do pose some potential pitfalls if you are not careful.
Assets that can be transferred using a beneficiary designation are generally considered to be “non-probate assets” or “testamentary substitutes.” Non-probate assets will transfer without the need for a will and without involving the court and the probate process. Examples of non-probate assets include IRAs, 401(k) plans, annuities, life insurance policies and certain types of bank or investment accounts.
There are several advantages to transferring assets through beneficiary designations. Naming a beneficiary is a relatively simple and inexpensive way to distribute your assets. For the most part, simply filling out the beneficiary form is all that is required. This tool also comes with the flexibility to change your planning quickly and easily by simply changing your beneficiary designations as necessary. Finally, because these assets will pass outside of probate, significant time and money can be saved.
Beneficiary designations can pose potential threats to your estate planning though. Who and how you name your beneficiaries can have a number of unintended consequences. First, properly naming your intended beneficiary is essential. It is not uncommon to have family members with similar names, or that change their names due to marriage or divorce. If a mistake is made or if there is some confusion as to who the intended beneficiary is, your family and loved ones may need to engage in protracted legal battles, defeating the very purpose of the beneficiary designation.
It is also imperative that you are careful who you name as a beneficiary of your assets. In some circumstances, it may not be a good idea to transfer assets directly to some of your loved ones. This could be true in the case of minors, those that may have trouble managing assets and have creditor issues, or individuals with special needs. For instance, an individual with special needs could lose government benefits if they suddenly receive a direct transfer of an asset such as life insurance or a retirement account. Situations such as these may best be addressed through the use of a trust which can control how the asset is distributed to the individual.
Utilizing beneficiary designations may also present the unintended consequence of an unequal distribution to your heirs. It is a common practice to include in our wills a provision that all assets are to be distributed to surviving children in equal proportions. However, because non-probate assets will transfer outside of the will, that wish could easily be undone if one child had been named as a beneficiary of a life insurance policy or retirement account for example. If that beneficiary designation had been forgotten about and never updated, that child would receive the non-probate asset together with the distribution under your will. It is not difficult to imagine the potential hurt feelings and even legal challenges in such a circumstance.
Additionally, in New York, a divorce will automatically terminate any beneficiary designations made in favor of the former spouse. Failure to update your beneficiary designations following a divorce could result in uncertainty, increased legal costs and even potential tax burdens to your heirs.
The best way to avoid any of these pitfalls is to ensure that your beneficiary designations are made as part of your overall estate planning. It is best to involve your legal and financial advisors to be sure that your beneficiary designations work with and not against your intended plan.
It is equally important to periodically check in with your advisors to review and update all of your estate plans, including your beneficiary designations. Family situations can change, including new marriages, deaths, etc., which may make it necessary that you update your beneficiary designations to fit in with your plan.