Young Couple ConcernedIt’s yet another necessary form in that seemingly endless pile of paperwork when completing a new insurance application. And, since the beneficiary designation can be changed at any time, does it really matter?

Of course it does — for two important reasons. First, as more and more assets pass by beneficiary designation, this form has become a person’s primary method of passing assets to their beneficiaries. Second, people rarely initiate changes in beneficiary designations, so a “temporary” solution may become permanent, perhaps with unintended results.

The increasing importance of beneficiary designations:

The scope of property passing by designation has increased significantly in recent years. Traditionally, this property was limited to life insurance, annuities, retirement accounts and bank accounts. More recent additions include all types of financial and securities accounts, and even real estate in some states.

Some of the accounts may be designated as “Transfer on Death” or “Payable on Death,” but the result is generally the same. It is the beneficiary designation and not the will that controls the disposition of this property at death. Consequently, people may find that few assets actually pass pursuant to traditional estate planning documents.

Since, as a matter of contract law, the property passes according to the designated beneficiary, the account agreement can impose restrictions and controls on the disposition of property. Acceptance of the beneficiary designation is at the discretion of the company; and designations that are long or complicated may be rejected or require additional documentation.

It is important to ensure that procedures are followed. In general, a beneficiary designation is not effective until it is received and accepted by the company. Simply mailing the form may not be sufficient; people should follow up with the insurance company to ensure that the beneficiary designation is properly recorded.

Circumstances change: 

An IRA payable to a former boyfriend? Life insurance payable to parents rather than the spouse and children? An annuity payable to a former spouse, a long dead relative or a former best friend who is now married to an ex-spouse?

The beneficiary designation may have been appropriate at the time — but times change. If you think an outdated beneficiary will “do the right thing” and hand over the money, think again. While it does happen, many cases prove otherwise.  The following are four common life changes to review:

1) Change in marital status

If a person is getting married for the first time, then he or she may want to change the beneficiary to the spouse; however, this change may be less likely if it is a second or later marriage. While naming the spouse as beneficiary is generally easy for accounts with current employers such as life insurance and retirement benefits, accounts at former employers or amounts that have been rolled over from former employers often get forgotten.

More frequently, problems usually arise when the person gets divorced. In some states, beneficiary designations cannot be changed until the divorce becomes final. In other states a divorce has the effect of cancelling all revocable designations for the former spouse. However, sometimes the former spouse has to be named as beneficiary while the children are minors. To avoid any uncertainty, people should update their beneficiary designations.

2) Birth or adoption of children or grandchildren

The birth or adoption of the first child usually prompts a major review of the estate plan and the need for new contingent beneficiaries. If a child is named individually (rather than as a member of a “my children” class), then the designation will need to be reviewed and possibly updated as additional children are born.

The same considerations apply to grandchildren. If children are adopted, it may be necessary to ensure they are included in the definition of children.

(3) Death of beneficiaries

The death of a spouse will likely prompt a major review of the beneficiary designations as property will now generally be passing to the next generation. Distribution options will have to be carefully considered as alternatives for children and/or trusts for their benefit may result in reduced or significantly different tax and payout consequences.

The death of one member in a group of beneficiaries may, depending on the account agreement, result in larger shares for the remaining beneficiaries. If this is not the intended result, then the designation needs to be updated.

The situation results in problems much more frequently than it should. A common situation is when “children” are designated as beneficiaries. Under some account agreements, the death of one child will result in the other living children receiving the share of the deceased child.

This excludes the descendants of the deceased child, a probably unintended consequence. To prevent this, the designation should be changed to include a share for the descendants of the deceased child or changed to “per stirpes.”

(4) Major life changes, change of plans and dislike of beneficiaries

A major life change, such as job change, relocation or retirement, is a good opportunity to review all details, including beneficiary designations, as part of the effort to consolidate and simplify planning.

As people age, their plans may change and their likes and dislikes may also change. The need for trusts for the children may either go away or become more important as they mature.

Concern about spouses of children may have diminished or become heightened. People may need more or less complicated planning because of the size of their estate, changes in tax laws or changes in states of residency.

Finally, beneficiaries may fall into and out of favor for all sorts of reasons. Changes for whatever reason need to be reflected in the beneficiary designations.

 

The tax information or estate planning information contained herein is general in nature, is provided for informational purposes only, and should not be construed as legal or tax advice.