Careful Planning to Avoid Mistakes When Naming Beneficiaries
by Don Drake, Connelly Law Offices, Ltd. 3.26.24
"The concept of naming a beneficiary is crucial, as it is a common practice regarding retirement accounts, wills, and trusts," explained Attorney RJ Connelly III, a professional fiduciary and certified elder law attorney. "In simple terms, a beneficiary is an individual or legal entity designated to receive the proceeds from a financial product or vehicle when the owner passes away. However, what may initially seem like a straightforward decision can become quite complex due to life changes such as divorce, death, wealth accumulation, and eligibility for government programs, among other factors. Hence, it's important to avoid mistakes when naming beneficiaries."
Attorney Connelly emphasized the importance of regularly updating beneficiaries as part of estate planning and financial wellness routines. He noted that this task is often overlooked during emotionally challenging times, such as during a divorce or after the passing of a loved one. Let's delve into some specific scenarios involving beneficiaries.
During a Divorce
"If you are going through a divorce, it's important to consider the wealth accumulated in various account types as a potential supplement to your retirement," stated Attorney Connelly. "Some accounts may have a death benefit that increases over time, which may be beneficial to retain. It's crucial to review existing life insurance policies, IRAs, and old 401(k) accounts, as they may still list your ex-spouse as the beneficiary."
While some states automatically terminate a former spouse’s beneficiary status upon divorce, this is not universally applicable, so verifying the status in your specific state is essential. Additionally, it's important to check for employer-provided policies with a former spouse designated as a beneficiary, as these are often overlooked. Attorney Connelly emphasizes the necessity of conducting a comprehensive financial review in these circumstances.
Distribution of Assets
When naming a beneficiary, it's important to consider potential negative financial impacts, especially in cases where it may affect government support programs. For example, a special-needs individual inheriting assets might lose eligibility for specific support programs, such as Medicaid, and must spend down the asset before reapplying for benefits.
"Inheritances can also have varying impacts on different siblings," said Attorney Connelly. "While splitting an estate equally among siblings may seem fair, it could have negative financial consequences. For instance, the affluent sibling may face increased tax liabilities and potentially be forced into a higher tax bracket, leading to a net loss. Meanwhile, other siblings may benefit more from inheriting additional funds. In such cases, it may be beneficial to consider alternative ways to distribute assets, such as providing physical assets to offset uneven inheritances."
Estate plans often involve straightforward arrangements with single beneficiaries, such as a spouse receiving a tax-free death benefit or directly inheriting a retirement account. However, family situations can be complex, and it may be necessary to distribute assets unevenly or differently to ensure fair outcomes for all involved.
Life Insurance Beneficiaries
"Life insurance policies can benefit an estate, but it's important to plan for their implications carefully," explained Attorney Connelly. "For example, if the life insurance death benefit is left to an estate, it could trigger probate and tax issues and may be accessible to creditors. This becomes even more complex if the policy includes retirement accounts or other financial assets, especially if they exceed the federal estate tax exemption threshold."
Using Trusts to Protect Beneficiaries
When naming your children as beneficiaries, especially on life insurance policies, it's crucial to consider the potential negative consequences of not doing appropriate planning.
Attorney Connelly highlighted that if your children are between 18 and 21 years old (depending on the state), they may inherit a substantial amount of money directly. However, younger individuals may not have the financial knowledge and maturity to handle a sudden inheritance. To address this issue, establishing a trust can be a highly beneficial solution. A trust can also allow children not yet of legal age to inherit the death benefit later.
He also emphasized the importance of a trust in structuring a minor child's finances with a named trustee, similar to how a will designates a legal guardian. Establishing a legal entity to provide for your minor children is far preferable to leaving money to another family member to care for them. In the latter scenario, there is no legal guarantee that the individual who inherits the money will use it to benefit your children.
Keep Beneficiaries "in the loop"
"I can't emphasize enough the importance of communication in estate planning, particularly when naming beneficiaries," said Attorney Connelly. "It's crucial for family members and loved ones to be informed about being named as beneficiaries, as it may affect taxes and government support programs. Additionally, communicating changes in beneficiary status can help manage expectations and prevent hurt feelings and family conflicts during an emotional time."
A Final Word
"Remember, it's important to reassess your estate plan as its value appreciates routinely," stated Attorney Connelly. "As the intricacy of your estate plan increases, it is imperative to verify that the designated beneficiaries align with your intentions and family dynamics. Taking proactive measures to update your beneficiary status following changes in your life circumstances and those of your beneficiaries is essential. This proactive approach will help ensure your estate plan remains genuinely advantageous and pertinent."
Please note that the information provided in this blog is not intended to and should not be construed as legal, financial, or medical advice. The content, materials, and information presented in this blog are solely for general informational purposes and may not be the most up-to-date information available regarding legal, financial, or medical matters. This blog may also contain links to other third-party websites that are included for the convenience of the reader or user. Please note that Connelly Law Offices, Ltd. does not necessarily recommend or endorse the contents of such third-party sites. If you have any particular legal matters, financial concerns, or medical issues, we strongly advise you to consult your attorney, professional fiduciary advisor, or medical provider.
Comments