This post will look at an important but sometimes overlooked aspect of Estate Planning; naming beneficiaries on insurance policies and other assets.
Upon the death of a person, a Will cannot transfer all assets. To transfer those not covered by the Will, the deceased must rely on a beneficiary designation. This essentially is a contract that governs certain assets. Examples include: life insurance, retirement plans, stock options, annuities, and deferred compensation plans. This beneficiary designation governs the passing of these assets. As a result, these assets pass outside of probate. The beneficiary does not have access to the asset until after the owner's death.
Primary and Contingent Beneficiaries:
When filling out a beneficiary designation form, the owner of the assets may designate two different types of beneficiaries:
- Primary beneficiaries – who are first to receive an asset
- Contingent beneficiaries – who receive the asset if the primary beneficiary predeceases the owner or disclaims (affirms that they do not want) the asset
The beneficiary does not have to be a single person, it could be an organization like a charity or multiple people. If the owner designates multiple persons as beneficiaries, they can allocate what percent passes to each person.
If there are no listed beneficiaries, then the asset passes according to the rules of the insurance company or brokerage. While rules may vary based on the asset or the institution, most follow the rule where a default beneficiary receives the asset upon the passing of the owner. More often than not, the default beneficiary is the owner's estate but that is not always the case and it may lead to an undesirable result for the client.
Use of Beneficiary Designations in Estate Planning:
Beneficiary designations are used by estate planning attorneys to:
- Avoid probate. Assets that transfer by beneficiary designation are non-probate unless the beneficiary is the estate.
- Transfer the benefit to the beneficiary upon the owner's death without the beneficiary having access to the right during the client's life.
- Create flexibility in estate plans.
These designations are become more important for both large and small estates because individuals are gaining more assets in retirement plans and life insurance.
Beneficiary Designations in Basic Estates:
A beneficiary designation is a simple and straightforward option for those who does not have a complex estate. This designation works best for someone who:
- Has a modest estate
- Only has a few assets they want to pass to designated persons
- Does not have sufficient assets to warrant creating a trust
- Most importantly, the person does not want the beneficiary to have access to the asset while the owner of the asset is still alive.
Beneficiary Designations can be used as the primary estate planning tool along with pay-on-death accounts and right of survivorship (or jointly owned) property.
Beneficiary Designations in Complex Estates:
Clients with blended families, varying assets, significant estates, or those that have trusts can still use Beneficiary Designations in estate planning. Instead of being a sole piece of estate planning, they are usually only part of a more complex system of designating who receives what assets. It is important to speak with your attorney about the assets you have and how each one will pass in order to ensure they all transition smoothly. If the designations are not coordinated properly, it can render the estate planning device ineffective. Some of the issues you will want to talk to your attorneys about are:
- The effect having a directed beneficiary will have on the estate plan
- Survivorship Issues
- Estate tax planning
- Retirement accounts
Advantages of Beneficiary Designation:
- Straightforward and easy concept for lay people to understand
- Inexpensive to complete Beneficiary Designation forms
- Can change beneficiaries at any time without the assistance of counsel
- Can have multiple beneficiaries and specify the percentages each person gets
- Assets pass outside of the probate process, saving time and money
- Named beneficiary usually receives the assets on completion and presentation of the claim form and proof of death, which is much faster than the probate process.
Disadvantages of Beneficiary Designation:
- Limited to simple transactions
- Beneficiary is paid outright regardless of their ability to manage money.
- Once the asset is distributed, assets are exposed to creditor claims
- Financial institutions may require that the client obtain the social security number of designated beneficiaries, which sometimes means the client must approach a beneficiary about the designation before death. This may decrease the client's ability to keep plan details private.
- Beneficiary Designation forms lack the safeguards to prevent against undue influence or lack of capacity
Death of a Beneficiary
- If primary beneficiary passes before the owner, the benefits will pass to a contingent beneficiary. If they also pre-decease the owner or there is not one named, the benefit will pass to the default beneficiary according to the institution in control of the asset.
- You should update your beneficiary every time someone dies to avoid unfavorable tax consequences.
- Assets generally cannot be distributed to minor children.
- If the amount is under $10,000, the minor's parent or guardian may receive the funds on behalf of the child
- If the amount is over $10,000, the court must appoint a guardian to oversee the assets.
- The minor will have access to the assets once he or she turns 18 in New York State.
Beneficiaries with Disabilities
- A distribution to a beneficiary with disabilities may jeopardize the beneficiary's eligibility for certain government assistance programs. Talk to counsel about setting up special needs trusts.
Separation and Divorce
- In New York State a divorce, annulment, or judicial separation automatically terminates the former spouse's designation as the recipient of retirement accounts, Pay-on-Death accounts, life insurance policies, and transfers of property made in a Will.
- Clients must also notify financial institutions of a divorce, annulment, or judicial separation. Without receiving written notice of the termination of a marriage, a financial institution is entitled to rely on the beneficiary designation form on file and is not liable for paying out the asset to a former spouse.