The Importance of Beneficiary Designations in Estate Planning

When a person signs a will (or a will coupled with a revocable trust) in order to set forth a plan for the distribution of his or her estate following death, he or she often believes the estate plan is complete. But if the person has failed to carefully consider the beneficiary designations on life insurance policies, retirement accounts, and other assets, and coordinate those designations with the estate plan, the result following death may be quite different from what was intended.

Wills do not override beneficiary designations; rather, beneficiary designations ordinarily take precedence over wills. For example, if a will leaves everything a testator owns at the time of death to the spouse, and testator has a $1 million life insurance policy on which the couple’s three children have been designated as equal beneficiaries, the life insurance passes to the children at testator’s death, not to the spouse. This result arises because the language of the will works only to distribute the assets that are part of the testator’s “probate estate,” meaning those assets in testator’s sole name without beneficiary designations.

Examples of assets not part of the probate estate are assets with beneficiary designations (usually life insurance and retirement accounts, and sometimes bank and brokerage accounts), any assets with a “POD” (pay on death) or “TOD” (transfer on death) designation, and any assets titled in the names of two or more people as “joint tenants with right of survivorship” or “tenants by the entireties.”

Examples of Undesired Consequences

The following are examples of undesirable results that can arise from a failure to coordinate the beneficiary designations and title of assets with the estate plan:

1. Your will provides that if one of your children predeceases you, that child’s share of your estate passes to his or her descendants per stirpes (this means your child’s children would share equally their parent’s share of your estate). Your will also provides trusts to manage assets passing to your grandchildren under age 30.

   If you name your children as “TOD” beneficiaries on a brokerage account and one of your children predeceases you, whether your grandchildren receive their parent’s share as you intend depends on the beneficiary designation form, which could provide that the other beneficiaries named (i.e., your other children) are the recipients of the predeceased child’s share. Even if the beneficiary designation form provides what you want (that your grandchildren receive their deceased parent’s share) there will be no trust to age 30—instead the institution itself could hold the funds until the grandchildren reach age 18, with no ability for anyone to access the funds for their benefit unless a guardian is appointed, and with full distribution to the grandchildren when they reach 18.

2. You are a widow with two children. Your will gives everything to your children equally. Your primary assets are your house and a large bank account, roughly equal in value. You change the title on your house to you and your daughter as joint tenants with right of survivorship, and you name your son as the POD designee on the bank account. When you die, the house has appreciated by 20%, but the bank account value has remained the same. At your death, the assets pass directly to your children as a result of the title and beneficiary designation, rather than to them under your will. You intended to treat your two children equally; however, the joint ownership title and POD designation had the effect of benefiting your daughter to the detriment of your son.

3. Your will gives all of your assets to your wife, or if she predeceases you, to your trustee to hold in a special needs trust for your adult son, who is developmentally disabled and resides with you and your wife. Your son is applying for Medicaid and other governmental benefits and should not receive any assets outright as this will disqualify him. You have a life insurance policy that names your wife as primary beneficiary with no contingent beneficiary named. However, the policy provisions indicate that in the absence of a named contingent beneficiary, the proceeds will pay to your then living descendants per stirpes.

   Your wife predeceases you. On your death, unless you change the beneficiary designation, the proceeds will be paid to your son outright rather than to the special needs trust under your will. While your son could create a Medicaid qualified trust for his own benefit, such a trust must include a payback provision

4. New Jersey law provides that when a divorce judgment has been obtained, unless the parties have agreed otherwise the spouse is automatically removed as a beneficiary and fiduciary from any estate planning documents, and is also removed as a beneficiary of any life insurance policies; however, this is not the case regarding employer-provided retirement accounts. Assume you have a 401(k) plan and your marital settlement agreement with your second wife provides this account is entirely yours. You meant to change the beneficiary from your ex-wife to your children from your first marriage, but had not done so at the time of your death. New Jersey law does not automatically negate the 401(k) plan beneficiary designation as a result of the divorce, and your ex-spouse may be able to claim the account. While your estate and your children may have a claim against your ex based on the marital settlement agreement, the time and expense associated with proving that claim could have been avoided had the beneficiary designation been appropriately changed.

Takeaways

• The way assets are titled can also serve, in effect, as a beneficiary designation. For example, an asset titled in two or more persons as “joint tenants with right of survivorship” will pass on one joint owner’s death to the surviving joint owner or owners. Be careful how your title your assets, and be aware that if you name a joint owner, that person is the one who will receive the asset at your death.
• Do not fall into the trap of completing a beneficiary designation on an account that shouldn’t have one 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 in keeping with your estate plan.
• A judgment of divorce can override beneficiary designations in some states, but do not rely on the law. 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, such as retirement, birth of a grandchild, death of a beneficiary, etc. 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.