The last will and testament and the revocable trust are the most common documents used within an estate plan to direct how an individual’s assets should be distributed in the event of death. However, for most individuals, a large portion of their assets does not actually pass according to that will or trust, but is instead controlled by “beneficiary designations.”
IRAs, 401(k)s, 403(B)s, annuities and life insurance are the most common examples of assets with beneficiary designations. “Transfer on Death” or “Payable on Death” designations, which may be found on bank accounts, investment accounts or even real estate, are also both a form of beneficiary designation. Upon the owner’s death, the beneficiary listed on these designations will receive those funds regardless of what the owner’s will or trust may provide. It is, therefore, crucial to address all forms of beneficiary designation and coordinate them with the overall estate plan.
Improper, incomplete or outdated beneficiary designations may cause unnecessary taxes to be paid or may cause the funds to be distributed in the wrong manner or even to the wrong recipients entirely. For example, it is common for parents of minor children to direct in their estate plan that the assets are to be distributed to a trust for the benefit of their children if both parents die. The purpose of this minors’ trust is to ensure the funds are available to be used for the children, but to also keep them under the management of a trustee chosen by the parents until the children are older.
However, if the beneficiary designations on the parents’ life insurance policies list simply “children” or list the children by individual name, those funds will not be distributed to the children’s trust. Instead, the funds would be distributed to the children outright. If a child is still a minor the funds would be held by a guardian until the child reaches the age of majority, at which time they would be turned over to the child without any restrictions. In this instance, the beneficiary designations on the life insurance policies should have directed the proceeds to pay out to the trust for the children.
Beneficiary designations are an integral part of almost every estate plan, but if completed incorrectly, they may derail the entire plan. A thorough estate plan will ensure not only that a will or a trust is in place, but also that all beneficiary designations are coordinated with those documents as well as with the overall goals of the estate plan.