Beneficiary designation exists for vehicles, bank accounts, and smaller properties, but they are most utilized in retirement accounts and life insurance policies. A beneficiary designation provides the basis for an immediate transfer of any assets to that beneficiary upon the original owner’s death. Beneficiary designations bypass the probate process and are subject to unique federal and state rules.
In almost all cases, beneficiary designation overrides a will. This means if you write in your will that you leave your motorcycle to your youngest son from a second marriage, but your first daughter’s named as the beneficiary designation, then the motorcycle will go to your daughter, regardless of what your will says. It is clear, then, that keeping beneficiary designations updated is important.
Beneficiary designation supersedes prenuptial agreements, divorce proceedings, and avoid probate. You can force the contents of an IRA or a life insurance policy to go through probate by naming your estate as the account’s direct beneficiary, but there is usually no practical reason for doing this. It simply invites more hassle and far greater costs into the process.
When utilized correctly, a beneficiary designation can be a godsend for any estate plan looking to maximize how much of a person’s estate is passed onto their loved ones – and once you begin familiarizing yourself with the opportunities at hand, you may find other assets and accounts that could be directly transferred to a loved one upon death.
The “Hidden Law of Succession”
A report by the New York University Law Review shed some light on a growing issue that affects millions of Americans, who may not even be aware of how beneficiary designations play a role in their estate. IRAs and life insurance policies are just some examples of accounts and assets that estate planners generally advise you do not include in a trust or will.
The reason being that each of these is set up with one or more beneficiaries in mind, and that chances are that if you have a retirement account, you’ve already listed a loved one as the sole beneficiary of that account years or decades ago, and you may have forgotten who or why.
These forgotten accounts and assets make up a considerable chunk (and the largest non-probate chunk) of the estimated $68 trillion that are expected to change hands over the coming years, as the Baby Boomer generation leaves their wealth behind for future generations to inherit.
Dubbed the greatest wealth transfer in history, the fact that a considerable portion of that wealth may be transferred to people through beneficiary designations that ignore wills and later estate planning documents can be worrying. And even if you remain committed to your earlier choice in beneficiary, there are still amendments to be made to reduce your beneficiary’s potential tax burden, help them make the most of the money you’re leaving behind, and more.
Reviewing and Changing Your Beneficiary Designation(s)
Understanding that your beneficiary designations from years prior can override your most recent wills and trusts is one thing, but amending it is another. While you are in the process of doing so, it helps to consider what options you have as an account holder of a life insurance policy or retirement account.
If, for example, you wish to divide your life insurance policy among several individual loved ones to ensure they each get an equal or equitable share, you can amend your beneficiary designation to specify each person and the percentage share they are supposed to receive.
Alternatively, if you have one beneficiary but are worried that a large six-figure lump sum may be overwhelming for a young person, you can stipulate that the payout will be stretched over a period of up to maximally ten years (for non-spouses), with various other options. You can have annual payments in the form of an annuity, or a period certain annuity that offers greater flexibility and choice.
This option is also ideal if you find that your beneficiary is well-off to begin with, and you would like to minimize the tax impact of their inheritance, and don’t feel that they need a large windfall to remain successful. If you designate multiple beneficiaries, but one of the dies before you do, the default option in many cases is that their share is split between the remaining beneficiaries.
However, you can instead indicate that, should one of the beneficiaries pass away before you do, their share will instead go to a secondary beneficiary, which could be a completely unrelated person, or the first beneficiary’s heirs or spouse. It is important to name secondary or contingent beneficiaries to ensure that if anything happens to the first beneficiary, you can still control how your assets are distributed.
Naming a Trust as a Beneficiary
Naming your estate as a beneficiary has its drawbacks, the biggest being that it forces the contents of your account (or asset, if you named a beneficiary on a vehicle or property) to go through the probate process. The probate process can be lengthy and expensive, and it becomes lengthier the larger and more complex an estate becomes.
Trimming your estate, or more precisely trimming what goes through probate can help you expedite the process and ensure that your loved ones receive more of their inheritance, and at a faster pace. However, you do have the option of naming a trust as a beneficiary for your accounts. You can also name an irrevocable trust as owner of a life insurance policy.
There are several reasons behind doing this. Life insurance trusts, for example, take ownership over an insurance policy for you. The reason behind doing this is simple: a very large insurance policy (seven figures and more) can heavily contribute to your estate’s value, which may lead you to go over the exemption limit on the federal estate tax.
This estate tax can be quite hefty, so staying underneath the exemption limit on the total value of your estate is in your best interest. An irrevocable trust taking ownership of your life insurance policy will ensure that the payout will still go to the beneficiaries designated in your policy. But because you no longer own it, and because irrevocable trusts are completely divorced from their grantors, the contents of the life insurance policy will no longer count towards your estate’s net value.
However, rules are different for retirement benefits. You should not write a retirement account into a trust. Doing so will count as a taxable distribution under income tax. Instead, name your trust as beneficiary, and then have your trustee distribute the contents of that trust to your loved ones, as per the additional control and options provided by a trust.
Specific details such as these vary greatly from situation to situation and may be subject to state-specific rules. If you wish to amend your beneficiary designations and learn more about how you can put them to use in your individualized estate plan, contact an estate planning professional.