Even after a pandemic heightened awareness of the importance of naming beneficiaries for estate planning, some clients still might not understand or pay attention to how critical these designations are.
“Clients misunderstand, overlook and even ignore beneficiary designations,” said Benjamin Bohlmann of Friedman LLP in Miami, adding that he’s “no longer surprised at finding an ex-spouse listed as the primary beneficiary of a large life insurance policy. After the insured’s death, that’s a problem without a solution.”
A bad designation can cause tax and other trouble with numerous planning tools. “Listing ‘payable to my estate’ can have disastrous results, [such as] inclusion in a taxable estate and being distributed according to the decedent’s will rather than some other intended result,” he said.
“We find that as folks’ life circumstances change and shift, their beneficiary designations do not,” said Katelyn Murray, a CFP at Kendall Capital in Rockville, Md. “In addition to updating your beneficiary on file for your accounts as a result of the death of beneficiaries, divorce or new children who are born—just to name a few instances—we have a standard practice of reviewing our clients’ beneficiaries on file every two or three years.”
“It’s not that clients have a misconception about beneficiary designations. It’s that they tend to name beneficiaries and then don’t change them when their beneficiary designation no longer reflects their wishes,” said Karen L. Goldberg, partner-in-charge of EisnerAmper’s Trusts and Estates Group in New York.
“Many mistakenly believe that their last will and testament will direct where their assets go after they pass away. This is only true for probate assets,” added Robert Polans, a CPA at Drucker & Scaccetti in Philadelphia.
The wisdom of beneficiary designations can vary by type of asset. Such non-probate assets as qualified retirement plan assets, traditional and Roth IRAs, tax-deferred annuities, life insurance policies and assets within most inter-vivos trusts are directed only by a beneficiary designation.
“If you will leave behind significant non-probate assets including retirement accounts, also consider as part of your overall estate plan whether these assets should be directed into trusts to benefit your beneficiaries,” Polans said. “Trusts can provide a level of asset protection, including protecting a beneficiary’s inheritance from litigation or creditors, divorce proceedings, from reckless spending habits or from poor investment decisions by the beneficiary. Trusts can also keep assets within the family if a beneficiary dies prematurely.”
Bohlman said, “We stress to clients that life insurance proceeds, gifts and bequests escape federal income taxation in the hands of the recipients. The key is to avoid missteps and traps – inclusion in a taxable estate, not qualifying for the annual gift exclusion. Non-tax factors are closely linked to tax factors: lack of liquidity in an estate, bequests that may be lost to a beneficiary’s creditors, having to go through probate.”
Designations can be key from a tax perspective for, say, retirement plans. If the spouse is the beneficiary, the plan won’t incur estate tax taxable until the surviving spouse’s death, and he or she can take distributions over their remaining life expectancy after the required age.