When most people think of estate planning, Wills and Trusts come to mind first. Often, however, the beneficiary designation placed on life insurance policies, retirement plan accounts and other accounts with the option to transfer by beneficiary designation, such as Pay-on-Death (POD) or Transfer-on-Death (TOD) accounts, may actually transfer a significant portion of the person’s estate. By naming individuals as beneficiaries of these accounts, the assets will never pass through the Will to be governed by its terms. That may be fine in some situations, but not in others. It is a good idea to review your beneficiary designations, along with the Wills and Trusts under your estate plan, with your estate planning attorney at least every five years. Several general rules about beneficiary designations are discussed in this article. Here are a few things to consider:
Avoid naming minor children as direct beneficiaries
Typically, a couple wants to name each other as the primary beneficiary of life insurance and retirement account proceeds, with children named as contingent beneficiaries. If the children are below the ages at which the parents are comfortable with them receiving the proceeds outright, and especially when the children are below age 19 in Alabama, a better plan is to name a trust set up for the children as the beneficiary. This trust might be in a separate document, like a Revocable Trust set up under a parent’s estate plan, or a trust set up for the children under the parents’ Wills.
It may also be important to consider the percentages that would pass to a particular child’s trust in determining the proper beneficiary designation.
Many life insurance beneficiary forms have provisions for distribution of proceeds to a minor beneficiary in a way that facilitates the distribution. If a minor beneficiary is named without this type of instruction, then in the absence of a trustee or custodial designation, the law requires a court proceeding be held to appoint a conservator for the minor child who will receive the insurance benefits. The delays and expenses associated with this proceeding can be frustrating. Plus, the funds must be paid outright to the child at age 19 in a conservatorship. That may be far too young for the amount of money that would pass to the child from life insurance, retirement proceeds, or other assets of which the child is a beneficiary.
Your estate planning attorney can help you develop a simple beneficiary designation that coordinates with your documents to have a Trustee or a custodian under the Alabama Uniform Transfers to Minors Act manage the proceeds for a child until the right ages.
Avoid creditor claims
When an estate plan has been implemented, it is tempting to name the “estate” itself as beneficiary of insurance and retirement benefits. After all, this takes care of the minor beneficiary problem. Naming an individual’s estate as beneficiary creates other problems, however. These funds are made subject to creditor claims that could be made against the estate. Alabama law provides that insurance proceeds made payable to an individual, a trust for an individual or a person other than the insured individual or the trustee of a trust for a particular beneficiary are not subject to claims against the estate. For example, if the decedent’s spouse is named as the primary beneficiary, the funds avoid creditor claims. By naming the contingent beneficiary as “the Trustee of the Trust under the Will of [name of insured],” the insurance proceeds should be sheltered from creditors and flow to the trust for the children. If a person has a trust as part of his or her estate plan that provides for the surviving spouse and the children, then naming that Trust as beneficiary avoids creditor claims while preserving the goals of the estate plan.
Consider the purpose of insurance coverage
On personal insurance policies, many name their spouse as beneficiary of the proceeds, with the children (or a trust for the children) named as secondary beneficiary. When potential estate taxes are not a concern, assuming the purpose of the coverage is to support the spouse and children, this plan works. However, if the purpose of the insurance is to be available for payment of estate taxes, or to be available in the context of providing liquidity to purchase a business interest, or the policy is owned by an Irrevocable Life Insurance Trust, it is important to name the particular trust or other intended designee to receive the proceeds. Your estate planning attorney can assist in determining the proper designation.
Qualified retirement plans
Qualified Retirement Plan proceeds, such as IRA’s and 401(k)’s, often represent a significant portion of a person’s total assets. When your spouse is intended as primary beneficiary, with your adult children as contingent beneficiaries, the situation is easy: these intended beneficiaries can be named to directly receive the proceeds without having to involve a trust or your estate. Income tax rules for qualified retirement assets and required minimum distributions favor this scenario. As previously described, however, where minor beneficiaries are a possibility, or where the asset is to provide for a spouse for life and then pass to children from a previous marriage, or creditor problems exist for a beneficiary, a different designation may be needed. Accordingly, your Will, Trust, and beneficiary designations all need to be coordinated so that they don’t work at cross purposes. In particular, naming your “estate” as beneficiary of qualified assets may result in tax problems (aside from potential creditor claims). Similarly, problems can result when a Trust is named as beneficiary, if the Trust is not drafted correctly.
While a discussion of the minimum distribution rules for IRA beneficiaries is beyond the scope of this article, most experts agree that having the option to “stretch” out payments results in income tax savings and growth of the account for the beneficiary. It is important to have an estate planning attorney review beneficiary designations for retirement assets to ensure that serious problems are avoided. Without proper planning, a mandatory five-year payout rule may apply to the distribution of retirement proceeds.
As is often the case, what seems like a simple process that anyone can do without legal advice is not at all simple. Indeed, the belief that you can “just go on-line and fill out a form” to designate your beneficiaries of life insurance proceeds, retirement accounts and other assets with beneficiary designations can easily result in an income tax or distribution disaster. It is best to call your estate planning attorney and make sure that your beneficiary designations are completed correctly.