When you first buy a life insurance policy or open a retirement account, you will be given the option to name designated beneficiaries—meaning the people that would receive the money after you pass away. How you choose to utilize beneficiary designations is very important. These designations overrule a person’s Will. For instance, if someone with three children has a life insurance policy and names their daughter as the beneficiary under the policy, but leaves everything under their Will to the three children equally, the daughter will receive the entire insurance payout when the policyholder dies. Because beneficiary designations take precedence over any contrary designations in a Will, it is crucial to ensure that any beneficiary designations correspond with the provisions of your Will (unless, of course, it is your intention to give unequal amounts of money to your beneficiaries).
Often times beneficiary designations are made by people when they first begin working at a company and then may not be reviewed again for years—if ever! These beneficiary designations can be easily forgotten and therein lies the problem. An article in the Wall Street Journal highlighted a story where an employee named a live-in girlfriend when he began working, they split up, and the employee then died forty years later. As it turned out, he never updated his beneficiary designation and his million dollar retirement account remains in dispute.
In addition to naming a beneficiary on your life insurance policy, individual retirement account (IRA), 401(k) plan, or other retirement plan, we are aware of bank employees suggesting to account holders that they name a pay on death (POD) or transfer on death (TOD) beneficiary on a bank account. If you follow the banker’s advice and name a POD or TOD beneficiary on your bank account, this means that you are instructing the bank to transfer the money in your bank account to the named beneficiary when you pass away. What the banker describes as an easy, routine procedure has the potential to completely ruin a person’s estate plan.
It also bears keeping in mind that once a married couple divorces, any gift that one spouse made via a Will to the other is void. The law in this case gets it right in that if you divorce someone, you would no longer want them to get any of your property when you pass away. This rule does not help you if your divorced spouse remains one of your designated beneficiaries!
Other issues relating to designated beneficiaries that are not covered by this article include the pitfalls of naming one child with instructions to “do the right thing” and divvy up the gift after you are gone (which can have tax ramifications, among other problems) and the massive income tax hit that can occur if a retirement account is paid to your estate or to certain beneficiaries directly instead of to a properly drafted trust for them.
When selected thoughtfully and with an overall estate plan in mind, beneficiary designations might add convenience and cost savings for the beneficiaries; however, it is critical that the beneficiary designations you have made match or otherwise coordinate with the provisions of your Will (or Revocable Trust). If not, whoever is named as the beneficiary under the policy or account will take that property upon your passing, not whoever is named in the Will. Sorting through these policies and accounts can be confusing and honest mistakes may not be remedied after you are gone. When in doubt, consult with an estate planning attorney about these issues to ensure that all of your “nest egg” passes the way you wish.