Tuesday, May 03, 2005

Estate Plan Checkup - Who are your Designated Beneficiaries

I was recently reminded of how critical it is for a client to periodically review his or her beneficiary designations to be sure they fit into the client's overall estate plan. Most people, as employees, acquire many benefits where they are asked to name a beneficiary - these might include 401(k), IRA, employer provided life insurance, stock options, deferred compensation or a host of other benefits. As a general rule, upon your death these benefits pass to the named beneficiary or "designated beneficiary" of the asset - they do not pass through your Will or Revocable Trust. This can create a huge disparity and unintended consequences where the "who" and "how" of your designated beneficiaries do not match your estate plan.

Retirement plan savings in particular make up a good portion of many people's net worth. Even if you have spent hours setting up your estate plan, it is common for a more cavalier attitude to be taken towards beneficiary designations. At some point you were probably asked to complete some stacks paperwork naming your designated beneficiaries - maybe you named your spouse and then children, or maybe you forgot to complete the paperwork altogether; and you probably haven't given much thought to it since. Many people are under the common misconception that if they change their Will, the beneficiary designations will follow. This is not true - your beneficiary designations control who gets and how they get those specific assets at your death; your Will governs other assets in your own name at the time of your death. In your Will you may be leaving assets to a spouse or children in trust, or setting aside some percentage of assets among a group of people. The key to maximizing your beneficiary designations is matching them to your estate plan, and then making appropriate adjustments to account for the unique qualities of these benefits.

What can you do to review your beneficiary designations:

  1. Get a copy of the beneficiary designation currently on file with the benefit provider - not your copy, but their filed copy. Look to see who your primary and contingent beneficiaries are.
  2. In naming your spouse as your primary beneficiary, consider whether or not you have set up any trusts for your spouse in your estate plan. If so, speak to your attorney about the pros and cons on naming the trust as your beneficiary instead of your spouse.
  3. In naming your children as your primary or contingent beneficiaries, again consider whether or not you have set up any trusts for them as part of your estate plan. If so, shouldn't these assets be passing to the trusts as well, especially if the trusts were designed to govern the assets until your children had reached certain ages?
  4. See if you have named your estate as a beneficiary at all. If you have, you may have negative income tax consequences on your death. An estate must take full payout of retirement plan benefits within 5 years of the date of your death - and pay income tax on all untaxed portions upon receipt of payment. A better alternative is to name one or more individuals (or properly created trusts) as beneficiaries - an individual can stretch our receipt of the retirement plan distributions over their life expectant, and thus defer the payment of the any income tax.
  5. File your changed beneficiary designation, and get a filed copy for your records.

If you have made the investment to create and estate plan, you should review your beneficiary designations and speak to your estate planning attorney to make sure that all of your assets pass as part of one plan.

Note that there are significant and interesting questions of how to minimize income taxes on an inherited retirement plan - but that is for another post.

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