The Power of Beneficiary Designations

August 18, 2021
By Angela Baker, JD, CFP®, CDFA®, RICP®, CLTC, CASL®
Three generations on a beach West Financial Services

 

When a famous Hollywood actor died unexpectedly in 2008 at age 28, the will he had signed in 2003 named his parents and sisters as the beneficiaries of his estate. Unfortunately, he neglected to update his will in 2005 when his daughter was born. Were it not for the parents and sisters agreeing that his daughter should inherit the estate, honoring what they believed to be his wishes, his daughter would have been disinherited.

 

You may provide for your beneficiaries through your will or trust...however, your will does not control assets with a beneficiary designation.

In 2007, the same actor purchased a $10 million life insurance policy and designated his minor daughter as the sole beneficiary. This resulted in a lengthy and costly court process to appoint a legal guardian for her since minors cannot directly receive the proceeds of a life insurance policy.

In order to avoid such unintended consequences and ensure that your assets pass according to your wishes at your death, it’s essential to understand the power of beneficiary designations. You may designate individuals, charities, trusts, other organizations, or your estate as beneficiaries. Or, you may make no designation at all. Your beneficiary designations may be simple or complex. You may provide for your beneficiaries through your will or trust and by adding beneficiary designations to assets that you own. However, your will does not control assets with a beneficiary designation.

Generally, in order to add a beneficiary designation to an asset that you own, you must contact the financial institution or custodian where it is held and request a beneficiary designation form.

A Payable on Death (POD) designation is typically used for accounts that don’t have a specific beneficiary designation form, such as an individual savings account. A revocable trust can also be a POD beneficiary. A Transfer on Death (TOD) is similar to POD, but a TOD generally applies to stocks, bonds, mutual funds and other investment assets. In Virginia and Maryland, a TOD registration is permitted for vehicles. The transfer of real estate may be accomplished through the use of a TOD deed, also known as a beneficiary deed.

Retirement accounts — IRAs, 401(k)s — life insurance policies and annuities may be transferred at death through the use of a properly completed beneficiary designation form. The Secure Act, signed in December 2019, made significant changes to the manner in which some beneficiaries must take distributions from inherited traditional IRAs and inherited Roth IRAs. For additional insights, read Brian Mackin’s article, “Thanks for the IRA Assets…Now What?”

Beneficiary designations can also be specified as “per capita” or “per stirpes.” With a “per capita” designation, if you left an inheritance to your two children, and sibling A died, his share would transfer to sibling B. However, with a “per stirpes” beneficiary designation, sibling A’s share could be transferred to his children, and not to sibling B. 

The proper use of beneficiary designations on assets has a number of advantages. They are legally binding and difficult to contest. The asset will pass directly to the designated beneficiary upon presentation of a claim and proof of owner’s death to the appropriate financial institution or custodian. The asset will bypass probate and the associated time and costs involved. Taxes may be saved or deferred, and it is relatively easy to make and change your beneficiary designations during your lifetime. 

Any major life event, such as a marriage, divorce, birth of a child or death of a family member, is a trigger to update your beneficiary designations. Don’t neglect to coordinate your estate documents with your beneficiary designations.

This oversight could inadvertently result in the disinheritance of a loved one, the loss of government benefits for a disabled person, or could create a large tax problem. Finally, designate both a primary and contingent beneficiary.

Beneficiary designations are a powerful planning tool when used correctly. In order to ensure that your assets pass according to your wishes at your death, review your estate plan and beneficiary designations with your estate planning attorney and your investment professional every three to five years or following any significant life event or change in relevant legislation.

Read the Financial Planning Focus August 2021 »


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