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Beneficiary Designations: Who Gets What

April 16, 2010

You may think your estate planning troubles are over if you have a will or a will and a trust. However, the best-drafted estate planning documents in the world may not bring the intended results. Why? Because you have ignored an estate planning basic: the form in which your property is held.

Any good estate planning process includes a discussion of your assets: What do you own and how do you own it? Does the asset designate a beneficiary and, if so, who is the beneficiary? Do you own the asset jointly with anyone else? The purpose of these questions is to determine the steps you must take to make sure that your assets end up where you want them after your death.

There are two common forms of ownership that need special attention during the estate planning process: property with a designated beneficiary and property held jointly with another person.

Property that designates a beneficiary will pass to the beneficiary at your death. The beneficiary designation overrides the provisions of your will or trust. This is an especially significant issue if you have young children or other beneficiaries who should not receive assets outright. You may take great care crafting an estate plan to ensure your child's college expenses are paid if you should die prematurely, but if your largest asset is an insurance policy that names the child as beneficiary, your intention may not be met. The insurance proceeds will be paid over to your child at age 18 and your plans to preserve those funds in an educational trust will go up in smoke.

Similarly, you may wish to leave your estate to your children in equal shares. However, you may have a brokerage account that contains a TOD ("transfer on death") designation naming only one of your children. Will that child then share the proceeds of the account with your other children? He or she is under no legal obligation to do so; the account legally belongs to the designated child and no one else after your death. Further, if your child does choose to share the account with your other children, he or she will incur a federal gift tax liability if the amount given to siblings exceeds $12,000 (for 2006) per person in any one year.

A better option in both of the above scenarios would be to name your estate (or preferably, if you have one, your trust) as the beneficiary.

BUT….before you run out and change beneficiary designations, don't assume that naming your estate or trust as beneficiary is the right approach to take in every case. If you have a tax deferred savings plan, designating your estate or trust as beneficiary can, in some cases, produce a financial disaster. This category includes a 401(k) plan, KEOGH, 403(b) plan, IRA, and so forth. Such plans may produce a double tax whammy at your death: they will be subject to the federal estate tax if your taxable estate exceeds $2,000,000 (for 2006-2008) and the untaxed portion of the plan will also be subject to income tax. The following amounts will apply in the following years:

*(2011 is the Tax Act of 2001 sunset, and will revert to 2002 levels without further action by Congress).

If you are married, it is almost always more preferable to name your spouse as the beneficiary rather than your estate or trust. A spouse can use the unlimited marital deduction to avoid estate tax liability and can also roll the plan over in order take advantage of withdrawing the funds over a period of time, minimizing the income tax liability. While there are ways in which to have such a plan held by a marital trust in order to qualify for the marital deduction, only a trust specifically drafted for this purpose will qualify. You should not designate your estate or trust as beneficiary of this type of plan before talking to your attorney or tax advisor.

There are situations in which it is appropriate, and even preferable, to name an individual rather than your estate or trust as beneficiary of an insurance policy, an investment account, or other asset that permits a beneficiary designation. When you get ready to make a beneficiary designation, or if you want to review the ones you have already made, ask yourself this question: What beneficiary designation will be consistent with my overall estate plan?

In summary, remember that assets that designate a beneficiary will go to that beneficiary. The terms of your will or trust are immaterial to these transfers.

Problems can also arise if you own your property jointly with another person with rights of survivorship. Joint ownership, like a beneficiary designation, overrides the terms of your will or trust. Jointly held property will pass to the surviving joint owner, whether or not this is consistent with the terms of your estate plan. You can also view the article entitled "Joint Tenancy Between Generations".

This is intended as a source of general information. If you have questions or desire additional information, please contact Ryan M. Wilson at (517) 377-0897 or rwilson@fraserlawfirm.com.