According to a recent report, baby boomer parents in North America will transfer some $30 trillion to the next generation over the next 30 to 40 years. A significant portion of this wealth is held as non-probate assets and as such not transferred under a traditional estate plan (e.g., Last Will and Testament). In anticipation of this great asset transfer, educate yourself on the common pitfalls and best practices of beneficiary designations on your non-probate assets.
Probate v. Non-probate assets
Probate is a process that occurs after your death in which the court will determine who receives your property. These assets can consist of probate and non-probate assets. Probate assets are distributed to heirs by the court and non-probate assets bypass the court system and go directly to your beneficiaries. Examples of non-probate assets include bank or brokerage accounts held in joint tenancy, retirement accounts (e.g., IRAs, Roth IRAs, 401(k)s, 403(b)s, 457(b)s, pensions, etc.), life insurance death benefits, and residual value of annuities.
Primary v. Contingent Beneficiaries
On non-probate accounts the owner can name both primary and contingent beneficiaries. Upon your passing, the non-probate asset will be transferred to your primary beneficiary who will become the new owner. If the primary beneficiary predeceases you, the asset will instead be transferred to your contingent beneficiary. If you have not listed a contingent beneficiary and the primary beneficiary has predeceased you or you have failed to list a beneficiary at all, the non-probate asset will go into your general estate for distribution. In order to avoid the asset going into your general estate, it is recommended you name both a primary and contingent beneficiary on your non-probate assets.
Pitfalls to Avoid v. Best Practices
Pitfall #1: Naming your estate as a beneficiary or only naming a primary beneficiary.
As mentioned above, it is recommended that you name both a primary and contingent beneficiary. Typically, on non probate assets the spouse is listed as primary beneficiary. However, consider how the asset would transfer if something happened to both you and your spouse at the same time. If a contingent beneficiary was not named, the asset would be moved into your estate which could lead to some complications on the transfer of the asset. If the estate is the primary beneficiary or in the previously mentioned example, a contingent beneficiary was not named, and the asset moves into your estate, the asset will no longer be protected from creditors and could be used to pay off your creditors. Additionally, your heirs could wait a long time before they would receive the money. Using your estate as a primary beneficiary may also result in negative income tax treatment for retirement accounts.
BEST PRACTICE: Name a primary and contingent beneficiary and confirm that your estate is not listed as either.
Pitfall #2: Forgetting to update beneficiary designations.
Too often we list the beneficiaries at the time we initially open a bank account or obtain life insurance and then shortly thereafter forget either who we named or when we last reviewed the designations. However, considering and naming your beneficiary designations should not be a one-time occurrence. If you fail to update your beneficiary designations on your non-probate assets you run the risk that you will inadvertently leave the assets to someone you did not intend (e.g., ex-spouse).
BEST PRACTICE: Review beneficiary designations often and also upon life changes (e.g., divorce, death of beneficiary, birth of child/grandchild, etc.).
Pitfall #3: Making a dependent ineligible for government benefits.
If a dependent relies on government benefits such as Medicaid or Supplemental Social Security, such as a child with special needs, naming them as a primary beneficiary for a non probate asset, even a nominal asset, could put the dependent at risk of losing eligibility for the government benefits.
BEST PRACTICE: Rather than leaving the asset directly to the dependent, talk with an estate attorney or financial planner about the benefits of creating a special needs trust to be named as the beneficiary. A trustee, appointed by you, would have control over the assets to be used for the benefit of the dependent.
Pitfall #4: Not comparing beneficiary designations to estate planning documents and goals.
While preparing your estate planning documents, if you fail to consider your beneficiary designations you may undo your previous estate plans or overlook certain wealth transfer goals. For example, naming a spouse as primary beneficiary, then later divorcing. If you update your Will to remove your ex-spouse but fail to also update your beneficiary designations, regardless of what is in your Will, the non-probate assets will still transfer according to the listed beneficiaries.
BEST PRACTICE: Simultaneously review your current estate plan alongside your beneficiary designations to verify your estate plan goals are met.
Take time to review and "spruce up" your beneficiary designations and estate plan documents. If you have questions about how to properly name or review beneficiary designations, contact an estate attorney or financial planner for assistance. Do not wait until it is too late (after death) to realize that a few minutes now may have avoided hours of complications for your family in the future.