Most people have a substantial percentage of their assets in retirement accounts, stock accounts, bank accounts and insurance policies. These assets are held in “beneficiary form,” meaning you can name a beneficiary to receive the asset or payout at your death. An advantage to naming a beneficiary is that you can prevent such assets from passing through probate (saving court costs and attorney fees), but there are other, more important things to consider as well.
Here are ten common mistakes to avoid with your beneficiary designations and some suggestions on how best to avoid them:
1. Not Naming a Beneficiary at All. If you fail to name a beneficiary for an asset, it will probably go through probate. If it is a tax-deferred retirement account such as an IRA or 401(k), there will be some very unpleasant, avoidable tax consequences as well.
2. Not Naming Contingent Beneficiaries. People often believe they will simply name another beneficiary if one beneficiary dies. However, they might be incapacitated by an illness or accident and unable to name someone else when that time comes. If your primary beneficiary predeceases you and you have not named contingent beneficiaries prior to your death or incapacity, the same consequences will result as if you had not named a beneficiary at all.
3. Failing to Keep Beneficiary Designations Up-to-Date. Changing beneficiaries is an often over-looked task. Because assets held in beneficiary form by-pass probate if a beneficiary is named, your will does not control who receives them.
Particularly if you have ever been divorced, be sure that the beneficiaries named are the beneficiaries you want to receive your assets. It is a good idea to review and update your estate plan, including your beneficiary designations, at least every five years to ensure everything is consistent with your current goals.
4. Naming Minors as Direct Beneficiaries. As soon as a minor turns 18 years of age, they will be able to do whatever they want with the asset you left them. Giving an 18-year-old immediate access to a large sum of money is probably not in their best interests.
A trust can manage assets for anyone regardless of their age, distributing money for the benefit of a beneficiary until the trust ends when the beneficiary reaches a mature age and the remaining assets are distributed outright to the beneficiary. However, naming a trust as the beneficiary of a tax-deferred retirement account can have the same unpleasant tax consequences as letting the asset go to your estate. The IRS has special, complex rules concerning inherited retirement accounts. However, certain types of trusts, called “see-through” trusts, can avoid those consequences without giving your beneficiaries direct access to those accounts.
5. Naming Special Needs Individuals as Direct Beneficiaries. Naming a person receiving government benefits such as Supplemental Security Income (SSI) or medical assistance based on a disability as a direct beneficiary (even a direct beneficiary in your will) will most likely disqualify them from receiving governmental benefits until they have spent everything you left them.
A better option is to create a “supplemental needs” trust will allow your beneficiary to continue to receive government benefits and also have the benefit of the assets in the trust which can be used to supplement their needs.
6. Naming Financially Irresponsible Loved Ones as Direct Beneficiaries. Naming a financially irresponsible person as a direct beneficiary may serve only to contribute to a gambling or drug addiction, or result in assets being claimed by creditors in a bankruptcy or income tax proceeding.
Creating a “spendthrift” trust that can prevent a beneficiary from burning through assets you leave to the trust, and the trust will protect trust assets from the beneficiary’s creditors. Most trusts can have “spendthrift” provisions.
7. Naming Different Direct Beneficiaries on Assets. Naming different beneficiaries for each of your assets might create a satisfactory division of your total assets now, but it is very unlikely that the assets remaining at your death will be proportionally the same. The almost certain result will be family conflict. If naming the same beneficiaries for each asset is not advisable, a trust can avoid probate and divide assets exactly as you want no matter which assets you have left or who survives you.
8. Transferring Your Home to Children During Your Lifetime. Although real estate is not held in beneficiary form, it can pass outside of your will via a deed. Concerned about needing Medicaid in the near future and Medicaid estate recovery, some people give their home to their children so that the home is no longer in their name. Such a plan might avoid medicaid estate recovery but can have a negative affect on qualifying for Medicaid. In addition, giving the home to your children prior to your death can have negative capital gains tax consequences for them.
Worse yet, if your home is titled in your children’s name, it is subject to their creditors. A change in a child’s circumstances might make it difficult for them to pay their debts. Their creditors could force the sale of your home in order to collect what is owed them from the child’s share of the sale price. You will not be able to avoid this result by asking the child to give their interest in your home back to you. It is too late.
Medicaid planning is complicated and requires professional guidance. If transferring property prior to your death makes sense, there are ways to accomplish that without the risking the loss of your house to a child’s creditors.
9. Naming a Child as a Co-Owner. Some parents add a child to a bank account as a co-owner so that the child will be able to pay the parents bills with the parents funds. Often the parent expects the child to use the funds remaining in the account at the parent’s death to pay their final expenses and then divide the balance with their siblings.
Here are just a few potential problems:
- Creditor Issues – Similar to no. 8 above, once your child (or anyone else) becomes the co-owner of your account, half of your account will then become subject to the claims of that person’s creditors.
- Family conflict – Even if the original amount of the joint account is reasonably small, you may or, if you are incapacitated, your agent may transfer other assets of yours to the joint account – making the amount of the account substantially larger. If you wanted the child to divide the account with their siblings after your death and they do not, or even if you wanted to leave them the balance of the joint account as compensation for the time and effort they spent caring for you, whatever is in the joint account at the time of your death is almost certain to create conflict.
- Gift taxes – Adding a co-owner to your account is a gift under current tax laws. Depending on the value of the account, you may need to file a gift tax return and, even if gift taxes are not due at the time of the ownership transfer, the transfer could reduce the tax exemption for your estate. In addition, your child may be unable to distribute the account balance to their siblings without incurring their own gift tax consequences.
A durable power of attorney is a better way for someone else to manage your funds or pay your bills should you become incapacitated. You can give your agent broad or limited powers to deal with your assets. The trustee of a revocable trust can also manage your funds and pay your bills. There are also ways to compensation a child for caregiving that will likely avoid family conflict.
10. Inadequate Contingent Beneficiary Designations. Forms for beneficiary designations give you limited options, especially in the event of one co-beneficiary’s death. For example, suppose you have several children, all named as equal beneficiaries of your retirement account. One child predeceases you. Nothing else appearing, your retirement account would be divided only between the children who survive you, leaving out the grandchildren.
We can help you name contingent beneficiaries properly. Also, a trust can provide for contingent beneficiaries and contingent beneficiaries of the contingent beneficiaries, giving you many more options and much more flexibility.
Dealing adequately with beneficiary designations is just one part of a good estate plan. There are many other factors to consider and issues to address. We enjoy helping people develop thoughtful, understandable estate plans which address their unique concerns. Contact us by phone, by email, or through our website to schedule your appointment and begin developing your own estate plan.
The information you obtain at this site is not, nor is it intended to be, legal advice. You should consult an attorney for advice regarding your individual situation. We invite you to contact us and welcome your calls, letters and electronic mail. Contacting us does not create an attorney-client relationship. Please do not send any confidential information to us until such time as an attorney-client relationship has been established.