Now that you are finally getting around to having your Will prepared or updated, or even considering adding a Revocable Trust to your planning documents, it is also important to plan for those assets that are subject to a document commonly referred to as a beneficiary designation form. Most commonly, my clients inquire: Doesn’t my Will take care of these assets as well? The answer is “no.” Although in some cases you may desire that those assets be directed to your estate so that they pass through your Will, or even a trust you have created, you must do something to make that happen. That something is done through your beneficiary designation forms. This is of the utmost importance because the assets that pass by beneficiary designation may very well comprise a large percentage of your total assets.
Consider this, you may have set up trusts within your Will, or otherwise, for your children or other adult individuals, or perhaps even created a Supplemental Needs Trust for an individual with special needs. Unless you appropriately complete the beneficiary designation forms associated with your assets that pass using these forms, those assets will not pass to any type of trust.
In doing any estate planning, you must review and consider all of your assets and determine which ones are going to pass by a beneficiary designation form so that you can be sure that those assets also pass in accordance with your desired estate plan. Assets that pass by beneficiary designation form will pass outside of your Will or Revocable Trust unless you plan otherwise. This is important because in some cases there can be negative income tax consequences if certain assets pass through your Will.
So what is a beneficiary designation in any event?
The beneficiary designation is a form, which is actually a contract that an individual has with a financial institution, including an insurance company, which holds or manages your investments. It is the document that instructs the financial institution who the asset is to go to when you pass away. This document supersedes your Will or Revocable Trust.
Assets that are commonly associated with using beneficiary designation forms include life insurance, annuities, pensions, and retirement assets such as IRAs, 401(k)s, 403(b)s, as well as other types of retirement accounts. The format of beneficiary designation forms and often times the information requested for each form varies from institution to institution.
Once you determine which assets are subject to beneficiary designation forms, how do you coordinate your beneficiary designation forms with your estate plan, such as your Will or Revocable Trust?
If your intention is to leave these types of assets to individuals, you must consider who you want as your primary beneficiary(ies), the percentages of their respective shares, what proportion, if any, you want of each share to pass to a deceased primary beneficiary’s descendants or to the other surviving primary beneficiaries if that primary beneficiary should predecease you. Also, you must select contingent beneficiary(ies) as well.
Sometimes you will be able to identify your beneficiaries on the form itself and in the space provided. Often times, however, your attorney must prepare an additional document to do so. This is especially true when you desire to have an asset that passes by beneficiary designation to pass to a trust, or to allow a beneficiary to disclaim to a trust, or even when you merely do not have enough room on the form itself to identify your wishes.
Even when there is sufficient space on the form, often times the options provided to you are not what you desire. For example, if you desire that your asset that passes by beneficiary designation to pass to trusts for your children, or that special needs trust you created in your Will, or even as a stand alone trust, you will want to be sure that your completed beneficiary designation form properly identifies the trust for such an individual. You may desire that a surviving spouse be the primary beneficiary, but in the event that he or she desires to disclaim, that his or her disclaimed share passes to a disclaimer trust for the benefit of the surviving spouse as opposed to passing to the named contingent beneficiaries, i.e., the beneficiaries to receive the asset should your spouse predecease you.
Since most retirement assets are comprised of pre-tax dollars, when those assets are paid out, they are subject to income tax. In most cases, you will want to be able to obtain the longest payout period possible. When such assets are made payable to your estate, the Internal Revenue Code requires that the balance of such an asset be paid out by the end of the fifth year following an individual’s date of death if that individual died before reaching the age of 70 ½ . This may not be desirable in your situation. On the other hand, some assets customarily subject to beneficiary designation forms, such as life insurance, do not have the same income tax consequences. Therefore, you may want to have life insurance paid to your estate whereby on your death your debts can be paid off and the trusts in your Wills for your minor children can easily be funded.
There are many options and considerations in planning with your beneficiary designation forms. Each scenario is different for each individual and depends on many factors. Any complete estate plan must include a review of all of your assets (including those that pass on your death by beneficiary designation form), a coordination of those assets with your other assets, a review to ensure that those assets pass to whom and how you want them to, and a consideration of the income tax consequences as best as possible. Completing your beneficiary designation forms properly to achieve what you desire is equally as important as having a properly drafted Will and/or Trust put in place. If you fail to review and update your beneficiary designation forms, you may unwittingly defeat the estate plan you have put in place.