by Brooks Caston
Today, the beneficiary designation form has become one of the most important components of a client’s estate plan as an ever-increasing amount of a client’s wealth is comprised of assets, the disposition of which at the client’s death, is wholly subject to the terms of the beneficiary designation.
Characterization of Assets Controlled by a Beneficiary Designation. Unlike probate assets, which pass pursuant to the terms of an individual’s will, or pursuant to a state’s intestacy laws if the individual did not execute a will, assets distributed pursuant to the terms of a beneficiary designation are considered nonprobate assets because such assets pass solely pursuant to the terms of the designation form. In other words, the beneficiary designation supersedes the terms of a client’s will and/or trust.
Common Types of “Beneficiary Designation Assets.” Some examples of assets that are distributed pursuant to a beneficiary designation include the following: (1) Payable on Death Accounts (POD); (2) Transfer on Death Accounts (TOD); (3) life insurance; (4) annuities; (5) Individual Retirement Accounts (IRAs); (6) 401(k) plans; (7) pension plans; and (8) employee stock ownership plans (ESOPs).
Consequences for Failure to Align Beneficiary Designations with the Entire Estate Plan. As the examples below illustrate, failure to properly coordinate a client’s beneficiary designations with the rest of the estate plan can lead to disastrous outcomes:
Disinheritance: John Smith is a single individual. John’s estate consists primarily of a 401(k), a POD account, and a life insurance policy. John designated his brother, Bill, as the primary beneficiary on each beneficiary designation. Recently, John decided to leave everything to his sister, Jane, so John executed a will to provide as such. However, John dies before changing any of his beneficiary designations. As a result, the retirement and life insurance proceeds, as well as the funds in the POD account, all pass to Bill, notwithstanding the terms of John’s will leaving all of his property to Jane.
Unnecessary Tax Liability: Husband and wife have a total estate of $24,000,000 (for this example, the estate tax exemption amount is $11,000,000 per person). The estate is comprised entirely of assets controlled by a beneficiary designation form (e.g., POD accounts, life insurance and retirement accounts). Each beneficiary designation lists the spouse as the primary beneficiary. Husband and wife recently executed new tax planning wills (i.e., at the death of the first spouse, an amount equal to the estate tax exemption to a credit shelter trust, with any excess passing to a marital deduction trust).
Wife dies before she and husband revise their life insurance and retirement account beneficiary designations to coincide with their wills. As a result, all of the wife’s “beneficiary designation assets” cannot be used to fund the credit shelter and marital deduction trusts and instead pass to outright to the husband. While this outcome does not generate any estate tax liability at the wife’s death (due to the unlimited marital deduction), at the husband’s death, all $24,000,000 (assuming no change in value) will be included in the husband’s gross estate for estate tax purposes. Even if the husband utilized portability at the wife’s death (i.e., ported all of the wife’s remaining $11,000,000 unused estate tax exemption amount), and retained his full $11,000,000 exemption at death, at best, $2,000,000 would be subject to estate taxes.
Nullification of Trust Planning Benefits: Father executes a will leaving all of his property in a testamentary trust for the benefit of his only son, with such assets to be held in trust for the son’s lifetime. Father desires to leave the property in trust to protect such assets from his son’s potential future creditors (son works in a high risk profession as an anesthesiologist) and from claims from a potential future ex-spouse. Father’s estate is comprised of life insurance and retirement accounts, all with the son listed as the primary beneficiary. Father dies before updating his beneficiary designations to have the assets pass to his son’s testamentary trust. Consequently, the father’s assets will pass directly to the son, prohibiting the son from availing himself of the above-described asset protections available with the trust.
As this article demonstrates, a client’s estate planning objectives, contained within even the most skillfully constructed of estate plans, can be completely negated if the client’s beneficiary designations fail to align with the client’s overall estate plan. Therefore, it is incumbent upon the estate planner to commit the necessary time, attention and consideration towards ensuring the client’s beneficiary designations properly align with the client’s traditional estate planning documents and intentions.
Brooks L. Caston is an estate planning and probate attorney at Clark Hill Strasburger. He can be reached at firstname.lastname@example.org.