Unfortunately, people often create issues when using beneficiary designations. To avoid the most common issues, reviewed below, beneficiary designations need to be periodically reviewed, updated as needed and coordinated with rest of your estate plan.
Your designations should be reviewed periodically (every 12-18 months) and following any major life events. Generally, events such as retirement, serious illness, marriage, birth of a child or grandchild, starting your own business, divorce
and a death in family are all reasons to review your designations.
A part of the beneficiary review and updating process is to confirm that the designations on various documents and accounts are coordinated and consistent, which does not require they be identical. If the instructions on the various accounts
are different than instructions in will or trust, the designations on the accounts determine how that account is distributed. The beneficiary designations also need to be coordinated with the provisions of your will or trust.
If an account does not have a named beneficiary, it becomes part of the account owner’s estate and will be distributed through the probate process.
If the only named beneficiary dies before the account owner, the account balance / death benefit will be paid to the account owner’s estate. Many accounts list just a primary
beneficiary, usually a spouse based on presumption that spouse will outlive them. If spouses die in a common accident or in an unexpected order, this results is account being paid to account owner’s estate instead of a beneficiary.
By naming a secondary (contingent) beneficiary, account will not end up in estate if the primary beneficiary predeceases the account owner.
The main purpose of using beneficiary designations is to avoid the probate process. If an estate is named as the beneficiary, then account will become part of the probate estate instead of
being paid to the intended beneficiaries, the same as if no beneficiary was named.If the beneficiary of a retirement account (such as a 401(k) or IRA) is an estate, the account balance will need to be distributed over no more than
5 years, likely increasing the amount of taxes paid. If individual persons were named as the beneficiaries, the payout period could have been extended, generally lowering the amount of taxes paid.
Funds cannot be given directly to a minor. If a minor is named as a beneficiary, a judge will need to name a custodian for the funds. In most cases, the financial institution will require submission
of proof of the court’s appointment prior to releasing the funds to the custodian. The funds will be released to child when he/she reaches either 18 or 21, depending on state law. The court-appointed custodian may also deduct a
fee from the account for his / her services.An alternative to leaving the funds directly to a minor, would be to name the beneficiary as the custodian of a Uniform Transfers to Minors Act (UTMA) or Uniform Gift to Minors Act (UGMA)
account for the benefit of the minor. The funds will be transferred to the named beneficiary at the age provided in state statute, either 18 or 21. Generally, the custodian for multiple minors must be listed separately. This option
is simpler and less expensive than a court appointed custodian and allows parent to select person who has control of child’s funds.Another alternative would be to name the parent’s trust, if applicable, as the beneficiary. The
trust agreement would then direct the funds from that account to be placed in a designated subaccount for the benefit of the minor. This alternative has several advantages, including lower costs and ability to continue to hold
the funds in trust after the beneficiary turns 18 or 21, while making them available for child’s support and education.
A special needs person named as an account beneficiary may lose his/her needs-based government assistance upon receiving the funds. A better solution would be to name a special or supplemental
needs trust as the account’s beneficiary. The trust will need to exist prior to the account owner’s death.
For qualified funds, naming a trust as the beneficiary may limit the ability of the beneficiaries to defer the income taxes on the funds. If the trust does not qualify for pass-through treatment
(all trust beneficiaries are individuals), funds will need to be distributed (and taxed) in no more than 5 years. A trust named as a beneficiary will need to exist when account owner dies, or designation will fail and account will
be paid to the account owner’s estate.
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