Bequests & Beneficiaries: Do You Know The Difference?

Bequests & Beneficiaries: Do You Know The Difference?

The scenario plays out over and over again in attorneys’s offices: a family contacts the law office to have a deceased’s Living Trust administered or Will probated. The estate planning documents are complete and well thought-out, but upon reviewing the documents the family discovers that a significant portion of the estate will not be transferred to the beneficiaries.

Why, you ask? Because those assets were assigned to an individual (or individuals) via a beneficiary designation, and unfortunately the Trust or Will cannot override that election. To add insult to injury, the majority of an estate’s liquid assets will have named beneficiaries (think about life insurance or retirement accounts), tying up liquid assets at a time when survivors need the funds the most.

In addition, many financial institutions now offer their customers the opportunity to name beneficiaries on their accounts. The common titling is: TOD or “Transfer on Death”. These can include bank and brokerage accounts, mutual funds, and savings bonds. The upside of these arrangements is that when the account holder dies, the assets go directly to the beneficiary, bypassing a potentially lengthy and costly probate process. However, the drawback of beneficiary-designated assets is that they pass “under the radar” and can override directions spelled out in estate planning documents. This can lead to a host of unfortunate, unintended consequences: individuals who you no longer wish to inherit assets do; some may receive more assets than intended while others receive less—ultimately, as a result, not having enough money available to fund bequests laid out in your will.

Beneficiary Mishaps

Not naming beneficiaries, or failing to update forms if a beneficiary dies, can create a wave of unfortunate repercussions. This can be especially devastating when it comes to retirement accounts. Consider this: if the beneficiary of an IRA is a spouse and predeceases the account holder, what happens to the IRA when the account holder dies? Let’s further assume there are children involved. Without a contingent or back-up beneficiary, the IRA would typically pass to the estate instead of directly to the children, as the account holder likely would have preferred. Not only would this transfer generate a tax bill on the estate for the survivors, but it would also prevent the children from taking advantage of the Stretch IRA strategy, which would allow them to take out distributions over their lifetime.

In another common scenario, when a couple divorces, one or both may forget to update the beneficiary designations on their pensions, retirement account(s), or life insurance policies. After remarrying, if the ex-spouse passes away, his/her current spouse would not receive the assets; instead they would go to the first spouse. Finally, some people simply fail to name a beneficiary. I know it sounds strange, but trust me it does happen, because I’ve met with many people and discovered it during initial profiling sessions. When I ask about beneficiary designations for employer-sponsored plans, inevitably I’m told, “Oh, I named my wife/husband/sister.” But 3 times out of 10, when asked to produce the documents showing the beneficiary arrangement, we discover that there is none for at least one of their plans—be it a 401(k) or life insurance.

Best Practices

Given these scenarios, it is extremely important to work with an estate planning professional. They will make sure to coordinate your beneficiary-designated assets, as well as named bequests that are spelled out in your trust and/or will.

Make it a practice to review your beneficiary designations at least once a year or when there has been a life event such as the birth of a child, the death of a loved one, a divorce or a marriage.