Of all the important components of a good estate plan, the beneficiary designation may be the most frequently overlooked. Beneficiary designations are the documents, usually provided by a financial institution or insurance company, which allow you to direct to whom a particular asset should be distributed upon your death. Completing these beneficiary designation forms should be done under the guidance of an experienced estate planning attorney, in order to ensure that your objectives will be met by the designation(s) made.
In my years of practicing estate law, I have seen many tales of calamity and woe (as the kids say these days, “Epic Fails”) begin with either a failure to designate a beneficiary or contingent beneficiary, or naming a beneficiary with the expectation that the named beneficiary would distribute the funds to others in some manner as directed by the original owner.
Here are a couple examples (these are fictional hypotheticals, not references to actual clients):
Epic Fail #1:
Homer and Marge have three young children and have decided that they want Marge’s sister Patty to serve as guardian of their young children in the event that both Homer and Marge pass away. Homer and Marge decide that they will name Patty as the beneficiary of their life insurance policies since Patty will be caring for their children and will need that money to do so. Homer and Marge then pass away while the children are still minors. Upon their passing, all of the life insurance proceeds (pursuant to the beneficiary designation) pass automatically to Patty. Now what? There are lots of potential problems here. First, the life insurance proceeds are now legally Patty’s. She has no real guidance or obligation as to how to use these funds. She could use the funds to buy herself a vacation home, or anything else for that matter, with no regard for the intentions of Homer or Marge. In fact, Patty could make matters even worse by taking the money, renouncing her nomination as guardian and absconding with the money. In a real doomsday scenario, Patty could subsequently divorce and lose half of those insurance proceeds to her ex-spouse, or could be beset by some other financial hardship and lose the assets through collection proceedings. All of these scenarios would clearly defeat Homer and Marge’s original intent, which was that the funds be used for the benefit of their children. One easy solution to this potential problem, which would be quickly suggested by an experienced estate planning attorney had Homer and Marge consulted with one, would be to create either a living trust or a testamentary trust for the benefit of the children, and name that trust as the beneficiary. This would protect the assets, ensuring their use for the real intended purpose: caring for Homer and Marge’s children.
Epic Fail #2:
Peter has three adult children. Peter decides that he wants to name his oldest son, Chris, as the executor of his last will and testament. Peter has a $250,000 life insurance policy that he wants to be divided equally amongst his three children. Peter decides that he will name his son, Chris, as the beneficiary of the life insurance proceeds so that Chris will receive the funds and then distribute them equally amongst his siblings.
Peter then passes away and the funds are distributed directly to Chris. You can see this FAIL coming a mile away right? Chris decides he doesn’t really want to share his newly acquired funds with his siblings, and keeps the cash. The proceeds never become part of Fred’s probate estate, thus Chris has no obligation to distribute them according to the terms of the will. Here comes the litigation. Even if Chris had a change of heart and decided to share the proceeds with his siblings, Chris would technically be making a potentially taxable gift to his siblings in the amount of the shares distributed to them. Consultation with an attorney prior to Peter’s death would have likely informed Peter of this unfortunate possibility and Peter would have been presented other beneficiary designation options that would have actually accomplished his goal of each child receiving an equal share.
Epic Fail #3:
Roseanne has an IRA account containing $300,000. Roseanne names her husband , Dan, as the primary beneficiary of her IRA account. Roseanne neglected to name a contingent beneficiary on the form, as she either wasn’t sure what it meant, or didn’t believe it would be important. Dan then passed away in a tragic construction site accident. Roseanne died several year later, never having amended her beneficiary designation form after Dan’s passing. Depending on the plan document that governs the IRA accounts, the most likely result is that the IRA account would be payable to Roseanne’s estate. Because the IRA funds were essentially pre-tax dollars, any distributions of funds from the IRA would be a taxable event. The estate being the beneficiary of the IRA can severely limit the options for stretching out the withdrawals to minimize the tax consequence. Had Roseanne named her children, Becky, Darlene and D.J., as her contingent beneficiaries of the IRA account, then each of them could have elected individually how to withdraw the funds, so that each could tailor their individual tax consequence to best suit their needs.
If you have questions about beneficiary designations, or any other estate planning matters, please contact Halcomb Singler, LLP, at (317) 575-8222. Attorney Greg Halcomb routinely meets with clients to address these matters. As you can tell from the scenarios described herein, it is much better to address these questions and concerns at once, instead of waiting until it’s too late.