“During the estate planning process, these beneficiary designations are reviewed to ensure that the beneficiaries are correct, and that the distribution of these assets conforms with the client’s intended estate plan.”
Naming a beneficiary on a non-retirement account can result in an unintended consequence—it can even topple an entire estate plan—reports The National Law Review in the article “Overuse of Beneficiary Designations: How They Can Derail a Client’s Estate Plan.” How is that possible?
In most cases, retirement accounts and life insurance policies pass to beneficiaries as a result of the beneficiary designation form that is completed when someone opens a retirement account or purchases a life insurance plan. Most people don’t even think about those designations again, until they embark on the estate planning process, when they are reviewed.
The beneficiary designations are carefully tailored to allow the asset to pass through to the heir, often via trusts that have been created to achieve a variety of benefits. The use of beneficiary designations also allows the asset to remain outside of the estate, avoiding probate after death.
Apart from the beneficiary designations on retirement accounts and life insurance policies, beneficiary designations are also available through checking and savings accounts, CDs, U.S. Savings Bonds or investment accounts. The problem occurs when these assets are not considered during the estate planning process, potentially defeating the tax planning and distribution plans created.
The most common way this happens is when a well-meaning bank employee or financial advisor asks if the person would like to name a beneficiary and explains to the account holder how it will help their heirs avoid probate. However, if the estate planning lawyer, whose goal is to plan for the entire estate, is not informed of these beneficiary designations, there could be repercussions. Some of the unintended consequences include:
Loss of tax saving strategies. If the estate plan uses funding formulas to optimize tax savings by way of a credit shelter trust, marital trust or generation-skipping trust, the assets are not available to fund the trusts and the tax planning strategy may not work as intended.
Unintentional beneficiary exclusion. If all or a large portion of the assets pass directly to the beneficiaries, there may not be enough assets to satisfy bequests to other individuals or trust funds created by the estate plan.
Loss of creditor protection/asset management. Many estate plans are created with trusts intended to protect assets against creditor claims or to provide asset management for a beneficiary. If the assets pass directly to heirs, any protection created by the estate plan is lost.
Estate administration issues. If a large portion of the assets pass to beneficiaries directly, the administration of the estate—that means taxes, debts, and expenses—may be complicated by a lack of funds under the control of the executor and/or the fiduciary. If estate tax is due, the beneficiary of an account may be held liable for paying the proportionate share of any taxes.
Before adding a beneficiary designation to a non-retirement account, or changing a bank account to a POD (Payable on Death), speak with your estate planning attorney to ensure that the plan you put into place will work if you make these changes. When you review your estate plan, review beneficiary designations. The wrong step here could have a major impact for your heirs.
Reference: The National Law Review (Feb. 28, 2020) “Overuse of Beneficiary Designations: How They Can Derail a Client’s Estate Plan”