Don’t Forget to Audit Your Beneficiary Designations

In an ever increasing complex world, one aspect of your financial lives that is not always correct is the beneficiary of your retirement accounts, annuities and life insurance policies. A beneficiary receives the account or proceeds at the death of an individual. Your will does not control who gets these types of accounts, even if your will is more recent or changes what your distribution plan dictates. So, the main question is: What is the correct beneficiary designation? And, how do you make sure that your beneficiary designations are correct and coordinated with your goals, objectives and estate plan? The answer is to conduct "beneficiary audits."

A beneficiary audit is a review of the beneficiary designations on all of your retirement accounts, annuities and life insurance policies in light of your goals and objectives and the tax and non-tax laws regarding distributions for these types of financial accounts.

First, determine if the named beneficiary is the correct beneficiary. It is surprising how often the named beneficiary is 1) an ex-spouse; 2) someone's estate, which is disastrous in terms of payouts from retirement accounts and annuities and may cause the proceeds to increase court costs and be subject to the your creditors, even after your death; or 3) some other individual who you no longer have any contact with. Often, individuals who get married and have children forget to name their spouse, children or a trust for their benefit and instead the proceeds or account goes to a parent, sibling or ex-girlfriend. If you get divorced, married, have children or any other life-changing event, you must change, or at least review, all of your beneficiary designations. What's more, you must also review, and possibly change, all of your estate planning documents. In most states, settlement or divorce agreements, or a new marriage, do not supersede the beneficiary designation, and instead the named beneficiary inherits the assets, not the new spouse or family.

Second, determine if a minor is named as a beneficiary. In most states a minor (a child under the age of 18) may not receive the proceeds from a life insurance policy, annuity or retirement plan directly. Instead, if a minor is named, the minor's parent (or someone else) must normally go to the local court to become the minor's legal guardian. Not only does that cost in terms of legal and court fees, but it may be restrictive in terms of investments, and at the age of 18 all control passes to the minor. Moreover, the court may dictate how the funds can be used prior to the age of 18, and annual accountings must be filed. Finally, some states, as well as the District of Columbia, are increasingly reluctant to appoint the parent as the guardian, and instead will appoint a financial institution or attorney, thereby increasing the cost. 

Third, determine if a child or other person with special needs, or other issues, such as creditors, drugs, spending, and the like, are named beneficiary. If a child with special needs inherits life insurance proceeds or a retirement account directly, then that child's government benefits may be curtailed. If a child who has a creditor or a marriage problem inherits directly, creditors or a soon to be ex-spouse may have a claim to the inherited assets. If a person who has a drug or spending problem inherits directly, then the inherited assets may be spent or used quickly and unwisely, which may not be what you want.

If a minor or individual with special needs or other issues is the desired beneficiary, then a trust for the benefit of the minor or other individual must become the beneficiary, thereby avoiding any interaction with the court or subjecting the account to creditors, predators, ex-spouses or unnecessary spending. If the account is a life insurance policy or an annuity, a typical trust for the minor or other individual will work. However, if it is a retirement account, then the trust must have very special terms to make sure that when the trust receives the retirement account, that required minimum distributions can be "stretched" over the life expectancy of the minor or other individual. The most important and difficult aspect in drafting this type of trust is to make sure that no one who is older than the minor or the other primary beneficiary can ever receive any of the required minimum distributions that have been paid to the trust, but not then subsequently distributed to the minor or the other primary beneficiary for his or her benefit.

Fourth, determine if you have an estate tax concern and if the beneficiary of the retirement accounts, annuities and life insurance policies must be constructed in such a way as to facilitate the minimization of estate taxes. With life insurance policies, it may mean changing both the owner and the beneficiary. For retirement accounts and annuities, it may mean changing the beneficiary. However, if the beneficiary of a retirement account or annuity is a trust, it may mean that the income taxes owed on the retirement account or annuity may be accelerated, especially if the trust does not have the special provisions noted above. Not only is careful drafting by an experienced and knowledgeable estate planning attorney necessary, but the overall ownership and titling of your assets may need to be adjusted to insure the most tax efficient estate plan possible, from both an income and estate tax perspective.

It is incredibly important to ensure that the beneficiary designations of your retirement accounts, annuities and life insurance policies are correct. Not only must you make sure that your retirement accounts, annuities and life insurance policies are used appropriately by the right person after your death, but also that you protect the assets from unnecessary income and estate taxes, court intervention, creditors, predators, ex-spouses and the like. 

FPA member Gary Altman, J.D., L.L.M., CFP^®, is a principal and founder of the Maryland-based estate planning law firm of Altman & Associates.