When there is a Will, There is not necessarily a way...

7/17/2019

The Importance of Updating Beneficiary Designations

Question: What does $17 trillion represent?

Answer: The amount of money held in tax-deferred retirement account assets (i.e. IRAs, 401(k)s, etc.)

For many Americans, the bulk of their net worth is held in these retirement accounts. But many don’t understand the importance of one little form that governs the ultimate disposition of these assets—the beneficiary designation form.

There is a widespread misperception about how assets pass at death. Some assets are passed via will and are considered probate assets; but some assets are governed not by what the will dictates, but by the beneficiary designation. Some of these assets include retirement accounts and life insurance policies. Making sure beneficiary designations are complete and up to date is just as important as ensuring that you have other estate planning documents in place, such as a will, health care proxies and powers of attorney.

Here are some of the common mistakes that occur with beneficiary designation forms:

1. No beneficiary named — In the case of an IRA, not naming a beneficiary can mean that the ultimate recipient will have a shorter period of time to withdraw the funds than if a beneficiary had been named.

2. Naming the estate as beneficiary — If a beneficiary is not named or the beneficiary predeceases the IRA holder, the estate usually becomes the beneficiary. While you can name your estate as beneficiary of an IRA, it is generally not the best option. If the estate is beneficiary, the IRA becomes a probate asset and has to go through the probate process, which costs money and time. Additionally, the IRA would generally need to be paid out over a shorter period of time.

3. Lack of a contingent beneficiary — If the primary beneficiary dies before the IRA holder and no contingent beneficiary is named, the IRA will be deemed to have no beneficiary.

4. Not naming all children as beneficiaries — There have been cases where individuals have not named all their children as beneficiaries because there was not enough room on the form and because they thought that since all of the children were named in the will, it didn’t matter. Also, if you intend to leave your IRA to multiple children, make sure you define that you want it left in “equal shares.” There was a case where a mother with six children left out the words “equal shares” and as a result, the IRA custodian interpreted her intent was to leave the IRA to her first child with the other five as contingent beneficiaries.

5. Naming a minor child as a beneficiary — Since a minor lacks legal capacity, naming a minor child as beneficiary creates a set of problems. One alternative is to create a trust for the benefit of the child as beneficiary. Assuming the trust meets certain requirements, payments from the IRA could be
“stretched” over the child’s lifetime. Another alternative would be to name a custodian under the Uniform Gift to Minors Act (UGMA) for the benefit of the child. This is a less expensive option than creating a trust, but the downside is that the child will inherit the IRA outright when he/she turns 21.

6. Naming an ex-spouse — This is where things can get ugly. Even if the divorce agreement and property settlement stipulate that one spouse (the wife, let’s say) has no claim on her ex-husband’s IRA, if the beneficiary designation form isn’t updated, the ex-wife would be entitled to the IRA. There have been numerous instances where these disputes have ended up in court, and the court has unanimously upheld the validity of the beneficiary designation, regardless of what a will or divorce agreement says.

As you can see, it is important to understand the implications and importance of completing the beneficiary designation form correctly. These forms should be coordinated and consistent with your overall estate plan, and should be discussed with your advisor as well as an estate planning attorney if you have questions about the optimal designation for your unique situation. In addition, it is a worthwhile exercise to review these forms on an annual basis, or upon a change in life situation.
Loring Ward is not a legal or tax advisor. The information herein is general in nature and should not be considered legal or tax advice.

Investment advisory services provided by LWI Financial Inc. (“Loring Ward”). Securities transactions offered through its affiliate, Loring Ward Securities Inc., member FINRA/SIPC. IRN R 16-014 (1/18)