Your Beneficiary Designations – Are They Correct?

May 28, 2019

Beneficiary designations are an extremely important component of an estate plan.  They are found on many types of assets such as IRAs, 401Ks, life insurance and annuities and designate who receives the asset after the account owner passes away.  The primary advantage of a beneficiary designation is that asset ownership transfers without the complexities and cost of probate.

Problems Encountered 

Many beneficiary designations are put together without the advice of an estate planning attorney.  For example, in finalizing an insurance or IRA application, a financial professional will ask for the beneficiary’s name to keep the application process moving along.  The account-opening process is quick and does not lend itself to having an estate planning attorney coordinate beneficiary provisions with the estate plan.  Alternatively, consider the case where couples divorce and leave their ex-spouse as the beneficiary of a significant asset.  Copies of beneficiary designations are rarely kept with a person’s estate planning documents making the review of that important aspect very cumbersome.

Integral Part of an Estate Plan

A typical estate plan includes a revocable living trust as a person’s main document.  It details how ownership of the decedent’s assets shall pass at death.  The trust may contain restrictions that protect inherited assets and reduce income and estate taxes.  If a beneficiary designation bypasses those protective strategies, then the extensive planning endeavor may be undermined.

Strategies Affected

Consider some of the strategies crafted into a typical estate plan:

  • Estate Tax reduction.  For some, federal or state estate taxes may apply to the decedent’s estate.  A revocable trust (or will) may contain a format that takes advantage of the decedent’s estate tax exemptions by placing trust assets into further tax-advantaged trusts.  If a beneficiary designation distributes assets directly to an individual, the aforementioned strategies may never be implemented, and increased estate taxes may result.
  • Asset protection.  Having assets payable to a person’s trust may serve to place them into ongoing trusts for children.  Such children’s trusts can serve as a “back door prenuptial” by placing the assets beyond the reach of in-laws in divorce proceedings.  Also, assets inside of a children’s trust may be beyond the reach of creditors.
  • Trust as Beneficiary.  As noted, there may be important reasons to name a trust as the beneficiary of an IRA or similar asset, since there may be trust provisions that accomplish the owner’s goals.  If an IRA is payable to a trust, “see-through” trust language may be important to stretch out taxable payments over an extended period.  Also, if IRA or similar assets are paid to a trust that contains a “pecuniary” funding clause, income taxation could be accelerated.  So, there are many reasons to draft beneficiary designations carefully along with relevant trust provisions.

If a beneficiary provision transfers assets directly to an individual outside the terms of a trust, then the carefully crafted estate plan may never be fully implemented.  Careful beneficiary designation planning and periodic review must be done to be sure they accomplish a person’s goals embodied in his or her estate planning documents.   Lack of attention to beneficiary designation details can have a dramatic effect on an estate plan.

Michael C. Foltz, JD, CPA, CFP® is a BDF founding principal and founder of our Business Owner Team with an extensive background in law, tax and estate planning.  Mike shares his estate planning expertise by following the ever-changing federal and state estate tax laws and preparing education summaries for clients and team members.  Recognized by Chicago magazine as a Five Star Wealth Manager, Mike has given numerous presentations on estate planning to BDF clients and professional organizations such as the Exit Planning Institute and Illinois State Bar Association. Publications such as Inc. magazine and the Wall Street Journal have featured his insights into estate planning, and he has contributed to an estate-planning publication for Commerce Clearing House.