When I meet with clients, I always discuss beneficiary designations. These conversations are needed before any planning decisions are made. We must review assets and confirm the current designations. Once any new estate planning documents have been drafted and executed, changes of beneficiaries may be needed. It is also important to remind clients to continue to check their designations in case the beneficiaries need to be changed or updated due to life events. Americans now hold more and more of their wealth in retirement accounts, with $6.5 trillion held in IRAs, and $5.9 trillion in employer-based defined contribution plans like 401(k)s, according to the Investment Company Institute. All of these accounts require beneficiary designation forms to designate recipients upon the account holder’s death.
An individual’s probate estate is governed separately from accounts with beneficiary designations, which may include retirement accounts, life insurance policies, bank accounts, certificates of deposit, stocks, annuity contracts, bonds, and mutual funds. Some individuals assume that assets such as these will be distributed to a spouse or children automatically, or under the terms of the individual’s Will. Beneficiary designation forms are meant to be a straightforward method to bypass the probate process and allow the beneficiaries to receive funds in a timely manner. Generally speaking, only a beneficiary designation controls the distribution of these assets. If an individual’s Will designates one person as the beneficiary of an IRA and the beneficiary designation form for the IRA designates someone else, the designation form will control the distribution of the IRA. The only time a Will controls the disposition of these assets is if no designation form was completed or the designated beneficiary has predeceased the account holder. If intended beneficiaries predecease an individual, it is very important to update designation forms in order to avoid probating the asset, which can be costly and can create negative tax ramifications. Moreover, divorce does not automatically remove an ex-spouse as beneficiary.
A case I recently reviewed exemplifies the need to make sure designations are up to date. Leonard Smith, a North Carolina resident battling cancer, worked with his advisors to make sure his children received the balance of his retirement funds at his death. A year after Mr. Smith’s death in 2008, his children discovered an error on his IRA beneficiary designation form. Instead of specifically listing the names of his children along with the percentages designated to each heir, Smith wrote: “To be distributed pursuant to my last will and testament.” In certain cases this may be advisable depending on a client’s estate planning objectives; however, Smith’s mistake had the unintended consequence of leaving his IRA to his second wife of two months and not to his children, the intended beneficiaries.
Individuals have the responsibility to keep their beneficiary designation forms up-to-date and make changes when needed. Financial institutions rarely provide automatic reminders and frequently lose the designation forms. To prevent beneficiary designation form mishaps, advisors typically recommend the following:
- Once a year, review your beneficiary designation forms. It is important to keep these forms up-to-date and make sure your estate planning documents and designated beneficiaries on accounts do not contradict each other. New forms should be completed if there has been a birth, death, marriage, or divorce in the family. Most financial advisors or financial institutions can provide new designation forms via their websites or quickly when requested. If you decide to complete an online form, be sure to print a hard copy for your files. This may be needed later on if the institution loses the original designation form.
- When filling out a beneficiary designation form, remember to designate percentages next to the names of your beneficiaries. You can opt to use phrases such as “in equal shares” if you want the assets to be distributed equally, or “per stirpes” or “by right of representation” if you want a deceased beneficiary’s share to go to the beneficiaries’ descendants. Most beneficiary designation forms allow for these elections.
- Be sure to keep track of name or ownership changes of your financial institutions. It would be advisable to complete a new designation form if the institution where your assets are held changes its name or merges with another bank or other institution.
- Be sure to keep hard copies of your beneficiary designation forms, including your “payable on death” or “transfer on death” forms, in your estate planning file. If all of these forms are in your account online, keep hard copies on hand because computer systems change and the forms might be hard or impossible to track down, especially if the bank has merged or changed names.
- Consider hiring a team of professionals to assist you with your planning needs, including an attorney who specializes in estate planning, an accountant, and a certified financial advisor. Advisors who do not specialize in estate planning or understand your overall goals can make mistakes due to lack of experience.
Additionally, Professor Melanie Leslie of Benjamin N. Cardozo School of Law at Yeshiva University recently wrote an excellent article on this topic which can be found here.