Why Designated Beneficiaries Are Important in Estate Planning

Signing documents - Designating Beneficiary concept

Designating beneficiaries is an important but often overlooked aspect of a sound estate plan. Many people prepare their estate planning documents, such as their last will and testament or trust, but forget to verify and update beneficiary designations on financial accounts and other documents.

Updating designations is an important part of any estate plan. By reviewing, properly designating, and updating beneficiary designations, you ensure that your wishes will be carried out and that your estate plan is sound.

Beneficiary Designations as Part of Your Estate Plan

A will is the centerpiece of any good estate plan. By properly executing a will, you ensure that your assets will pass according to your wishes. But for many people, a significant portion of their personal wealth is contained in financial assets like life insurance policies, annuities, tax-favored accounts like IRAs and 401(k)s, and 529 accounts. These accounts have provisions, known as beneficiary designations, that appoint who will receive the contents of the account when you die. A designated beneficiary receives account assets without the need for the assets to pass through probate. The beneficiary designation controls the distribution of assets and overrides the provisions of your will or trust.

Advantages and Disadvantages of Using Beneficiary Designations

Using beneficiary designations is an easy, cost-effective way to transfer wealth. Upon your death, the contents of the account are payable directly to your named beneficiaries, without the need for probate proceedings. In addition, there are usually no tax implications to your beneficiaries.

However, when you use a beneficiary designation to transfer assets, you forfeit a certain amount of control. For example, your will might include a provision that your estate assets should be used to pay for your grandchildren’s college expenses. But if your life insurance benefits are left directly to your grandchildren, those funds are not restricted, and your grandchildren could use the funds however they wish.

Other problems can arise when you name minor children as beneficiaries. Financial institutions generally will not pay death benefits to children because they do not have the legal capacity to accept payment. In that scenario, the financial institution will set up a special bank account (called a Uniform Transfers to Minor Act, or UTMA account) to hold the assets, or the court will appoint a legal guardian for the child. Both of these processes can be costly and time-consuming. In both scenarios, the funds would be released to the child when the child reaches 18 years old, even if the child is not yet financially responsible.

The Difference Between a Will and Trust For Naming Beneficiaries

You can also use your will or trust to designate beneficiaries. However, there are important differences between these two estate planning tools and how they function.

Your will only controls assets that are subject to probate. Probate assets are those that are titled in your name alone and for which there is no designated beneficiary who will receive that asset upon your death. Financial assets that have beneficiary designations pass directly to the designated beneficiary and are not subject to probate.

A trust only controls the assets that it owns. Your trust can become the owner of an asset in two ways:

  1. You can transfer assets to the trust during your lifetime, or
  2. You can name your trust as the beneficiary of an asset upon your death, either in your will or pursuant to a beneficiary designation.

If you have both a will and a trust and your intention is to have all your assets distributed through your trust, your will should state that your trust is the sole beneficiary of your estate. This will ensure that the assets subject to probate end up in your trust once probate administration is completed.

The Importance of Coordinating Beneficiary Designations

Many people mistakenly believe that a will is all they need for their estate plan. However, a thoughtfully prepared estate plan should include a will, a financial power of attorney, a patient advocate designation with advance healthcare directive, and possibly a trust. But the estate planning process does not end there. An underrated and often overlooked aspect of estate planning is verifying and updating beneficiary designations.

Just like your estate plan should be periodically reviewed and updated, your beneficiary designations must likewise be reviewed and updated when your life circumstances change. You should review your estate plan and your beneficiary designations every three to five years or whenever a major life event occurs, such as a birth, a death, marriage or divorce, relocation, or a change of employment.

You should review your estate plan to make sure it accurately reflects your current wishes. And if a beneficiary designation or other element of your estate plan is out of date, you should update it immediately. Significant life events, such as a divorce, a death in the family, the creation of a trust, the birth of a child, or other major changes bring about the need to update your estate plan and your beneficiary designations.

Key Takeaways

  • The way assets are titled can serve as a beneficiary designation. Be careful how you title your assets, and be aware that if you name a joint owner, that person will receive the asset upon your death.
  • Do not fall into the trap of completing a beneficiary designation on an account just because the account agreement gives the option of naming a beneficiary. Do not rely on the advice of a low-level bank or investment firm employee about completing a beneficiary designation—always check with your estate planning attorney and other professional advisors to be sure any beneficiary designation is consistent with your estate plan.
  • If you are divorced, be sure your beneficiary designations are updated to reflect the marital settlement agreement with your ex-spouse and also work in concert with your post-divorce estate plan.
  • Review your beneficiary designations periodically, and be sure to do so after a major event in your life. Be aware that your beneficiary designations are as important as your will and other documents and should be considered an integral part of your estate plan.

Contact Ager Law for Experienced Estate Planning in Ann Arbor

Ager Law Office helps individuals and families with all aspects of estate planning. From our Ann Arbor office, we serve clients throughout Washtenaw County.

For additional information on our reasonable flat fees for estate planning services, contact our experienced estate planning attorney, Bill Ager.

Categories: Estate and Probate