Today, more of our assets and wealth are transferred via beneficiary designations than ever before. The transfers are outside of our Wills and Trusts and are not affected by the provisions of those documents. Therefore, it is important to understand the impact of these transfer provisions
Assets Involved: The transfer mechanism for retirement benefits such as IRAs, 401Ks, 457s, and tax-sheltered annuities are the beneficiary designations attached to each account. There are not affected by the language of your Will or Trust. It is important to check these to assure that they are correct.
If you are married, the primary beneficiary will be your spouse; however, there are secondary or contingent beneficiaries as well – those that would receive the assets if your spouse has died. Are these correct?
Many clients will state that they are leaving the retirement benefits to one child so that the bills can be paid and that the child will then distribute the money because he/she knows what the parents want. This is a risky manner to distribute these funds.
First, with retirement benefits, there is income tax associated with the with withdrawal of the funds. Therefore, the one child you name will incur the tax liability. Next, as a matter of law, once you name one child as the beneficiary, he/she is under no obligation to share any of the money with anyone. It goes directly to the beneficiary. While you may think that your children would not do this, or that your children will not fight over assets, the courts are clogged with cases of children fighting over assets.
If you want all of your children to share in the distribution of your IRAs or 401Ks, name each of them as a beneficiary.
The same advice goes for any other asset such as life insurance or bank accounts. Once you have passed away, the child beneficiary may decide to withhold all the money for him/herself.
Another designation is known as Payable on Death (POD) or Transfer on Death (TOD). These are utilized for bank or investment accounts. The individuals named will receive the account proceeds directly without using your Will or Trust.
These are important concepts to understand when doing your estate plan. If your will states divide all assets evenly among my children, but your beneficiary designations on your accounts state otherwise, it is the beneficiary designations that will control.
If you have three children and three CDs of equal value, wouldn’t it work to put one name on each? Only if you are not going to use the money in the CDs. Otherwise, if you use the money in CD number one first, and then half of the money in CD number two, one child will get the full amount, one will get half and one will get nothing.
Recognize also that in a Will or Trust, we place provisions concerning what happens if a beneficiary dies. This flexibility is not accorded to these beneficiary designations. It might well be up to the financial institution and its rules. Those rules will be interpreted according to the laws of the state in which the company conducts its business. Therefore, if a child dies, his share may or may not go to his children, irrespective of your wishes.
In conclusion, beneficiary designations have made estate planning easier but there are many pitfalls for the unwary. Make certain that you understand the implications.