In the process of preparing their estate plan, many people are surprised to learn that their wills or trusts generally do not control what happens to assets such as retirement plans, IRAs, life insurance, and annuities when they die. Rather, these assets are controlled by beneficiary designations that the person may have signed when opening the account or purchasing the life insurance. Here is a list of important points to consider in making sure your beneficiary designations coordinate effectively with your overall estate plan:
- Carefully determine the current status of the beneficiary designation on each retirement account or life insurance policy. Do not assume that a beneficiary designation on one account will be the same on other accounts. If there are multiple retirement accounts, find the beneficiary designation paperwork for each account. Also, applicable law requires that for qualified retirement accounts such as 401k plans (as well as IRAs in some states), the surviving spouse must sign a written consent if the account’s primary beneficiary will not be the surviving spouse.
- As life brings change, change your beneficiary designations. For example, upon a marriage, divorce, birth of a child, death of a previously-named beneficiary, or other significant life event, make sure your beneficiary designation on each account is updated.
- If a prospective beneficiary is a minor, young adult, has special needs, or has problems with creditors or chemical dependency, then carefully consider whether additional planning is necessary. For example, if a minor is a designated beneficiary under a life insurance policy, then absent other planning, it could be necessary to have a conservator appointed to manage the life insurance proceeds until the minor becomes an adult. However, as legal “adulthood” is 18 in most states, if the conservatorship ends at age 18, then the assets could be prematurely dissipated due to the young person’s inexperience or youthful indiscretions. If a special needs beneficiary is receiving governmental benefits, the receipt of such assets could cause those benefits to be curtailed or eliminated. Finally, if a beneficiary has problems with creditors (including a former spouse), then these assets could potentially become subject to the claims of these creditors.
In all these situations, if the retirement account or life insurance proceeds are payable to a trust that is specially designed for the intended beneficiary, then many of these problems can be avoided. Any such trust must be carefully drafted in order to obtain the best possible tax results.
- Beneficiary designations can also be incredibly important to proper tax planning. When a surviving spouse is named as the primary beneficiary of retirement accounts or IRAs, the spouse can “roll over” the account to his or her own IRA. In addition, if surviving children or other beneficiaries are named as beneficiaries of IRAs, current law allows these beneficiaries to maintain the account in an “inherited IRA,” which in turn allows them to only take required minimum distributions (or “RMDs”) based upon that beneficiary’s life expectancy. Hence, a younger beneficiary could potentially extend the tax-deferral benefits of an inherited IRA for decades following the death of the original IRA owner (this technique is sometimes referred to as a “stretch IRA”). Finally, for a life insurance policy, proper tax planning might include not only structuring beneficiary designations properly, but also causing the ownership of the policy to be owned by an individual other than the insured, or by a trust commonly known as an “irrevocable life insurance trust,” or “ILIT.”