Beneficiary Designations as Part of an Estate Plan

     Recently I sat down with the client who came to see me on the advice of his children. This client had more than a passing familiarity with estate plan documents and came to our meeting prepared to reject most of my advice for updating his estate plan. The client's primary argument against needing even a simple Will was his use of beneficiary designations naming each of his children as the beneficiary for various assets. As I reviewed the situation, the client's beneficiary designations were mostly correct and he had done a good job of naming primary and contingent beneficiaries for his major assets. We still decided to draft a simple Will to help organize the process of probate, but that got me thinking about the effectiveness of beneficiary designations in general.

     In most cases, beneficiary designations are the simplest manner of passing an asset at death without the need for that asset to pass through the Probate Court. Life insurance beneficiary designations, retirement plan beneficiary designations, and even "TOD" (transfer on death) designations used by banks circumvent the probate process. While this is a simple method, frequently requiring only the completion of a form, it may not be the most effective method. Due to the contractual nature of beneficiary designations, the institution holding the assets pays them directly to the named beneficiary. Unfortunately, there are scenarios where this will not happen smoothly, and the courts will become involved anyway.

     For example if your named beneficiary is incapacitated, a court-appointed Guardian or conservator will be required in order to take control of the assets. The same is also likely true if the designated beneficiary is a minor, because all financial institutions seek to avoid the potential liability of paying out to a minor, or even to a parent of the minor for the child's benefit.

Even if the beneficiary receives the assets directly from the financial institution there can still be many unintended consequences. The beneficiary of a tax-deferred retirement account may decide to cash out the asset immediately instead of taking advantage of the tax benefits of a long-term payout.

     Other designated beneficiaries may have creditor problems that consume their entire inheritance.. A spouse in divorce can reach assets received. For beneficiaries receiving federal government benefits, the sudden influx of money will likely cause the beneficiary to lose benefit eligibility.

     Frequently when we discuss beneficiary designations with our clients we recommend naming their Living Trust as the beneficiary so that the protections of the Trust extends to all of the client assets, and the Trust can act as a clearinghouse for the assets. This allows the Trust's "spendthrift" and "incapacitated beneficiary" clauses to protect the beneficiaries whose personal or financial situations might be otherwise disadvantaged by a sudden influx of money.

      This is not to say that beneficiary designations naming individuals are an ineffective form of estate planning. However, anyone relying on beneficiary designations to achieve their planning goals should take the time to review those designations and confirm they have not missed any major assets and that all contingencies are covered by those designations. As with the client who inspired me to consider this topic in the first place, it is also always advisable to execute at least a simple Will to organize the probate process and ensure that any assets passing through the Probate Court go go to those beneficiaries the client prefers.

Matt Ferrara