Overlooking Your Beneficiary Designations Can Be Hazardous To Your Planning
By: Randall A. Denha, J.D., LL.M.
When creating or reviewing an estate plan, reviewing beneficiary designations on retirement plans or life insurance policies may not be given the weight it deserves. The assumption is that a will or trust is enough to make sure your money goes where you want it to go when you pass.
There have been numerous cases of retirement account owners who have been divorced and remarried but have neglected to update their beneficiary designations accordingly. This can be quite frustrating for their survivors, who must battle in court for a legal determination of the true beneficiary. And the court’s ultimate decision may not be what the deceased would have wanted. A similar dilemma arises if some children are named as beneficiaries but the document isn’t updated to include those who were born after the initial designation. To prevent these situations, you should update your beneficiary designation immediately after you experience a change in family status and review it periodically so they never become outdated or incorrect. You can also draft customized beneficiary designations to address “what-if” situations. For instance, what if your primary beneficiary predeceases you and you fail to update the designation? What if the organization to which you leave your assets becomes defunct before it inherits the assets?
To understand the importance of designating a beneficiary, consider the Supreme Court case Hillman v. Maretta. Warren Hillman made his then-wife, Judy Maretta, the beneficiary of his life insurance policy. They eventually divorced, and Hillman remarried. However, he didn’t change the beneficiary on the policy from his ex-wife to his new wife. When Mr. Hillman passed, there were legal questions as to who would receive the money from the policy. The Supreme Court ruled unanimously in favor of Ms. Maretta, and she received nearly $125K in benefits from the policy. Mr. Hillman’s widow received nothing. In this case, federal law preempts state law regarding the designation of a beneficiary of a life insurance policy. In Virginia, the designation of a life insurance policy beneficiary is revoked upon entry of a decree as to the former spouse. Virginia law went a step further. It also allowed the heirs to sue the beneficiary to recover the life insurance proceeds if that beneficiary is the former spouse. However, the United States Supreme Court held that the life insurance company is entitled to rely upon the beneficiary designation, despite the state statute.
That is just one of many beneficiary designation disasters. Simply stating in your will how you want the money in a retirement account to be distributed is not enough. Having an up-to-date beneficiary designation can make sure your assets go where you intended.
You should select both primary and contingent beneficiaries. Contingent beneficiaries will inherit if the primary beneficiaries precede you in death. If you name your spouse as beneficiary, you can avoid income and estate taxes. Additionally, your spouse can roll over your retirement account to his or her own IRA.
Without living beneficiaries, your assets may be transferred to your estate and state law determines who receives it. The presumption is that the heirs named in your will should receive the proceeds, but this could be challenged as beneficiary designations may supersede your will. For example, if you name your best friend as beneficiary, forget to change the designation when your friend dies, and you later die, your friend’s spouse or children could claim the asset.
Beyond providing the security of having your assets go where you desire, beneficiary designations offer important tax advantages for your loved ones as well. A consequence of not naming a beneficiary or naming your estate as the beneficiary is that those assets may be completely taxable five years after death. By naming your loved ones or a trust as the beneficiary, the funds can be withdrawn over a longer period of time. This allows the accounts, such as a traditional IRA, to continue to grow tax-deferred. This is commonly referred to as a stretch-IRA.
A second advantage of naming beneficiaries is the ability to avoid probate. Probate is the legal process for distributing your assets after your death, and, in most cases, will not benefit your beneficiaries. It is often a time-consuming, expensive process that simply adds one more hoop for your heirs to jump through.
Beneficiary forms are easily obtainable from the institutions where you have accounts or may even be available online. Depending on the type of asset, you may need to ask for different forms. From a bank, you would request a “Payable on Death” form while non-retirement investments have “Transfer on Death” forms. For retirement accounts and life insurance policies, you only need to ask for a beneficiary designation form.
Obtaining the forms to update your beneficiary designations is an easy process; distributing your assets once you pass without designating a beneficiary isn’t. Taking the time to name and review your beneficiary designations can help you make sure your money goes where you intended.
