Understanding Beneficiary Designations

Ten Things Everyone Should Know

1. Don’t forget to name beneficiaries. Naming a beneficiary keeps you in control: at death, assets in the account are transferred to the person(s) you designate. What happens if you do not specify who the beneficiary(ies) will be?

  • In some cases, the governing agreement may provide for “default” beneficiaries. (By way of example, the Wells Fargo Advisors IRA Custodial Agreement provides that if no beneficiary is named, the account will pass first to the owner’s spouse, or if there is no spouse, to the owner’s surviving children, and then to the estate.) A provision of this type is usually helpful, but it ispossible that the default beneficiaries may not be who you intended.
  • If the governing agreement does not include default provisions (or if it does, but there are no persons in those categories), then the account typically becomes part of the probate estate. In some cases, this can result in delayed distributions, additional administrative costs, and unfavorable income tax treatment.

2. Name both primary and contingent beneficiaries. It’s a good practice to name a “back up” or contingent beneficiary in case the primary beneficiary predeceases you. Again, being specific can help you avoid unintended or unwelcome results.

3. Update for life events. Review your beneficiary designations regularly and update them as needed, based on major life events such as a birth, death, marriage or divorce. Failure to update designations can result in a transfer of assets to unintended beneficiaries — or leave out someone you might have wanted to include.

4. Read the instructions. Beneficiary designation forms are not all alike. Forms and governing agreements may vary considerably between financial institutions, and for different types of assets or accounts. Don’t just quickly fill in names – be sure to read the beneficiary designation form carefully.

5. Coordinate with your will and trust. Whenever you change your will or trust, be sure to talk with your attorney about your beneficiary designations. Precisely because your beneficiary designations operate independently of your will or trust, it is important to understand how all the different parts of your estate plan work as a whole.

6. Understand potential consequences of naming individual beneficiaries for particular assets. Consider the example of someone who established three equal accounts and named a different child as beneficiary of each. Over the years, some accounts grew more than others, so some beneficiaries got more and others less — which may not be what was originally intended.

 7. Avoid naming your estate as beneficiary. In most cases, this produces less-than-optimal results because it causes nonprobate assets to become subject to probate. And for IRAs and qualified retirement plans, there may be unfavorable income-tax consequences. The required minimum distribution (RMD) rules generally let an individual beneficiary “stretch” distributions over his or her life expectancy. An estate, however, has no life expectancy. And so, in most cases, taxable distributions must be made over a shorter time frame than would apply if an individual (or qualifying “look-through” trust) had been named as beneficiary.

 8. Use caution when naming a trust as beneficiary. Consult your attorney or CPA before naming a trust as beneficiary for IRAs, qualified retirement plans or annuities. In many cases, the governing document (the plan document or annuity contract) or tax law (the RMD rules) may require accelerated taxable distributions when a trust is beneficiary. There are situations where it makes sense to name a trust — for example, if your beneficiaries are minor children, in second-marriage situations, or if you want to control access to funds — but be sure you understand the tax consequences in advance.

 9. Be aware of tax consequences and planning opportunities. Many different types of assets can be transferred by a beneficiary designation. It’s helpful to work with an experienced tax advisor, who can help provide planning ideas that fit your particular situation. Here are some examples of beneficiary designation “fine tuning”:

  • Martha is a successful corporate executive. She has named a charity as beneficiary of a life insurance policy that she owns. She also has in-the-money nonqualified stock options, and has named her children as beneficiaries under the plan. Both assets are roughly the same value. Martha’s CPA pointed out that some simple changes in beneficiary planning could lead to a more attractive tax result. She suggested that perhaps it would work better to name the children to receive the income tax free insurance benefit, and leave the (normally taxable) nonqualified options to a tax-exempt charity.
  • Jorge, a widower, is retired. He has a qualified retirement plan from his former employer, which is his largest asset. Jorge has made it a habit to only take Requirement Minimum Distributions (RMDs) from the plan; he hopes to pass these amounts on to his daughter Lourdes, who is named as beneficiary. Jorge explained to his estate planning attorney that one of his goals is to give Lourdes, after his death, the opportunity to “stretch out” distributions and continue tax deferral to the greatest extent possible. His attorney pointed out that while employer plans routinely offer extended distribution options for former employees and their spouses, they often require non-spouse beneficiaries to use a more rapid distribution method. However, the employer-sponsored plan must allow a non-spouse beneficiary to directly transfer the inherited plan assets to an inherited IRA. Jorge’s attorney advised him to check the specific terms of his plan to see what distribution options would be available to non-spouse beneficiaries. If the plan terms would permit extended distribution options, Lourdes might want to keep the funds with the employer’s plan; but if the plan terms require more accelerated distributions, Lourdes might want to consider transferring the assets to an inherited IRA afterher father’s death.

10. Use disclaimers when necessary — but be careful. Sometimes a beneficiary may want to decline assets that he or she would otherwise receive. This might be motivated by estate planning considerations, income taxes, estate equalization or re-distribution, or seeking a way to “repair” an unintended result that would otherwise occur. In some cases, it is possible to achieve a different asset distribution or “fix” beneficiary designation mistakes by using a disclaimer — a legal document that lets the named beneficiary irrevocably refuse the asset. It’s important to understand that the disclaiming beneficiary cannot direct where the asset will go. Instead, when a beneficiary disclaims, the asset passes to whomever is next in line on the beneficiary form, or if there is no other named beneficiaries, to the contract defaults. Disclaimers involve complex legal and tax issues and require careful consultation with your attorney and CPA.

Trust services are offered through banking and trust affiliates in addition to non-affiliated companies. Our firm and its affiliates do not provide tax or legal advice. Please consult with your tax and/or legal advisor before taking any action that may have tax and/or legal consequences.

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