One aspect of estate planning that can often be overlooked is making sure your beneficiary designations are up to date. Many people think that once you have signed your Last Will and Testament, your estate plan is complete. Not so fast! This may surprise you, but oftentimes a person’s Will governs very few assets at the time of their death. Consider retirement accounts and life insurance: it is not the Will, but rather the beneficiary designation that these assets have that will govern who receives it at the time of death.
While beneficiary designations are convenient and relatively simple to use (without the aid of an attorney), this also means there are more opportunity for mistakes! The purpose of this article is to outline the five most common mistakes we often see made with beneficiary designations, and how to make sure you avoid them yourself.
Mistake #1: Assuming you have a Designation
This first mistake happens most often when people incorrectly assume their Last Will and Testament will “take care of everything”, when the reality is assets should have a beneficiary designation (such as a life insurance policy). The bottom line here is this: don’t assume!
Mistake #2: Designation is Not Up to Date
A second mistake people make is assuming their beneficiary designation is up to date. But when was the last time you reviewed the designation? Have there been significant life events since you last signed the designation that might warrant a change? We make it a habit to regularly review our client’s beneficiary designations because we know that life happens, and what once may have been a perfectly acceptable designation can now be woefully out-of-date.
Mistake #3: Failure to Consider Contingencies
A third mistake is failing to consider contingencies when designating your beneficiaries. For example, you may designate your spouse as primary beneficiary of your IRA, and then your two adult children as equal, contingent beneficiaries. But what happens if one of your children predeceases you? Have you addressed this in the designation? Would their share pass to their children? Their siblings? Many people are surprised to know that most ‘boilerplate’ IRA forms say that if one of your beneficiaries dies before you die, their share will NOT go to their children, but rather will be divided proportionally amount the other named beneficiaries. This may not be the result you intend!
Mistake #4: Designation is Inconsistent with the Estate Planning Documents
A fourth mistake is when the designation is inconsistent with your estate planning documents. For example, in your estate planning documents, you may decide to leave assets to a beneficiary in a trust. The reasons for leaving an inheritance in trust will vary (for example, the beneficiary could have special needs), but those reasons are important, and you can thwart your own planning if you then leave that same beneficiary a large retirement account outright and not in a trust.
Mistake #5: Beneficiary Designation Overuse
Finally, because beneficiary designations are so easy to use, there sometimes can be a trend toward beneficiary designation overuse. Beware of getting carried away!
Consider the following example: a person’s Last Will and Testament provides that upon their death, they desire their estate to be divided as follows:
100% to the person’s children, A and B.
However, this person also wants some money to go to a certain charity when they die. Rather than pay an attorney to update their estate plan, this person instead chooses to revise the beneficiary designation on their 401(k) as follows:
100% to Charity X.
While there is nothing wrong with what this person did, it could present a dilemma to the family. If this person becomes incapacitated and their children (A and B) are trying to figure out how to pay for the bills, can/should they use the funds in the 401(k) to do so? While it may make sense from an income tax standpoint for them to do so, it would look bad for A and B because now they are spending all of Charity X’s inheritance and none of theirs. This can be a problem!
It may have been better for this person to structure their estate plan differently to avoid this kind of uncomfortable situation for their children.
Beneficiary designations are wonderful tools (and not just for probate avoidance), and you should use them. But this does not mean they are without risk! Your beneficiary designations should be thoughtfully planned and should receive regular review. We would love to talk with you about this if you have additional questions about your beneficiary designations.