Beneficiary Designations – the Importance of Proper Planning

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:

  1. 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.
  2. 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.
  3. 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.

  4. 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.”


Fill Out Your Beneficiary Forms Carefully

There are three ways that ownership of an asset is transferred at death – by law (a joint tenancy arrangement for example), by bequest (through a will or trust) and by contract (through the use of a beneficiary designation). The Appeals Court of Oregon’s recent decision in the case In re Marriage of Keller (232 Or.App. 341) reminds us that an individual that is planning on transferring assets through the use of beneficiary designations (primarily insurance proceeds and IRA/pension benefits) must make sure that the beneficiaries stated on the plan or the policy match up with his or her planning objectives.

In Keller, the court was presented with a complicated (but not uncommon) family situation. A man and his wife agreed to a divorce decree in which the husband retained ownership of a number of assets, including several insurance policies. The divorce agreement contained a provision which read, in part, “each party releases and relinquishes any and all claims or rights which he or she may now have, may have had, or may have in the future against the other as a result of the marriage of the parties, including but not limited to spousal support.”

After the husband’s death, the executor of his estate determined that the decedent’s ex-spouse was still listed as a beneficiary on one insurance policy. The executor asked the ex-spouse to disclaim the insurance proceeds, the ex-spouse refused, and the executor sued the ex-spouse for violating the clause spelled out above. Three-and-a-half years later, the parties have received two judgments and are still fighting. The trial court ruled in favor of the ex-spouse and the Appeals Court of Oregon recently remanded the trial court decision and sent the case back to the lower court for a more detailed analysis of the divorce agreement entered into by the parties.

The moral of the story? When developing (and revising) an estate plan, it is important to pay particular attention to the individuals that you have named as beneficiaries on insurance policies, IRA accounts and pension plans. Incorrectly naming the beneficiaries on these accounts can leave to prolonged court battles and unexpected (and expensive) results.