“Probate” is a dirty word to most people.
Sure, sometimes it can be helpful. But you generally want to avoid it.
Think of it like the raw broccoli that for some reason is included on every party platter everywhere, but without the dip. No dip, just raw broccoli. Avoid. It.
One of the ways to avoid probate is by naming beneficiaries on your financial accounts and contractual policies.
In estate planning, a beneficiary is a person or entity who receives part of your estate after your death. You can name a beneficiary through your estate planning documents OR through a contract such as a life insurance policy, IRA, or agreement with your bank.
If you designate a beneficiary on an account or policy, then the assets or proceeds of that account or policy will pass directly to the named beneficiary, probate-free, after your death.
Sounds cool, right?
Right. It is very cool.
However, sometimes beneficiary designations can have unintended (and undesirable) consequences. Here are some mistakes to avoid when naming beneficiaries:
1. Not naming a beneficiary
This one seems obvious, but it’s worth mentioning because it is so easy to avoid.
If you do not name a beneficiary (or take other steps to avoid probate), you are virtually ensuring that your estate will be probated. And although probate is not the worst thing in the world, it is costly and time consuming. It is also usually avoidable.
Even if you believe all your accounts and policies have named beneficiaries, double check. Triple check. Check once a year. Do everything you can to make sure you don’t make the silly mistake of forgetting to name a beneficiary.
However, designating beneficiaries is not always as easy as it sounds…
2. Having outdated beneficiaries
News flash: times change.
Relationships change. Tastes change.
You can get divorced or separated. You can gain children or grandchildren. Relatives can get married. A hundred different factors can influence how you want to see your estate distributed.
What if one of your children was denied an inheritance?
If you do not regularly review your beneficiary designations, both of those things could happen.
Beneficiaries can also die. If you name John as the pay-on-death (POD) beneficiary of your bank account, and then John dies before you, that account may be subject to probate unless you name a new beneficiary. And the person who ultimately gets your money may not be the person you intended.
3. Overriding your estate planning documents
Let’s say you have two kids, John and Jane.
Your Last Will and Testament says that John gets 1/2 of your estate and Jane gets the other 1/2. When you die, your only asset is a bank account with $100,000 in it, and John is listed as the POD beneficiary.
Who gets what?
In this scenario, John gets $100,000 and Jane gets nothing.
Naming beneficiaries is a great way to avoid probate. However, this example demonstrates the importance of remembering one important thing:
Beneficiary designations can override your estate plan.
As you list beneficiaries, be sure those designations gel with your estate planning goals so that you do not inadvertently disinherit a child or provide for vastly unequal distributions.
4. Naming a beneficiary with special needs
In an estate planning context, an individual with “special needs” generally refers to a person who receives (or qualifies for) government aid for a disability. This aid can be vital to maintaining that individual’s care and quality of life.
However, most “special needs” aid programs are contingent upon the person having below a certain amount of assets and income. In other words, if a special-needs beneficiary receives too much money, they may be disqualified from government aid!
You leave your child an inheritance to improve their quality of life, not diminish it. But that’s exactly what you could inadvertently do. Not only would the beneficiary be forced to “spend down” his inheritance, but he must also go through the application process again to requalify for aid.
Obviously, you want to avoid this result. To avoid jeopardizing benefits, consider creating a “special needs trust” (also known as a “supplemental needs trust”) or talk to an attorney about other estate planning options.
5. Naming minor children as beneficiaries
If you name a minor child as a beneficiary on an insurance policy, for instance, the child will be able to access those funds once he or she reaches age 18 (or 21, depending on your state).
But consider this: do you really want to give your child control over hundreds of thousands — or even millions — of dollars right when they turn 18? would you have trusted yourself with that much money when you were 18?
Providing an 18-year-old access to that kind of money could be disastrous. Perhaps they spend it too quickly or make unwise investments. Suddenly, the assets you spent decades building — and which were meant to provide for your kids for many, many years — are gone.
Most young adults do not have experience managing that large a sum of money, and they may not have a full appreciation of that wealth.
However, even if your kids are financially responsible, divorce or creditors may still result in them losing a sizable chunk of their inheritance.
Rather than risking giving your child hundreds of thousands of dollars when he or she turns 18, consider a trust or some other estate planning device that can better regulate when and how your child receives an inheritance.
Not only does this help protect the assets of your estate (and provide for your children), but it, hopefully, gives your child a greater appreciation for the wealth they inherit.
6. Designating a beneficiary on a joint account
Let’s say you have a bank account with $100,000. You want to leave your entire estate to your only child, so you list her as the POD beneficiary of the account.
In your final days, because it is increasingly difficult for you to manage your assets, you name your brother as a joint owner of the bank account so he can access funds to pay your bills. You die shortly thereafter.
Who gets the account?
Even though your daughter is listed as the POD beneficiary, the account only pays on the death of all account owners. Because your brother is a joint owner, the assets become his after you die. He can withdraw those funds or change the beneficiary designation however he wishes.
And just like that, you unintentionally disinherited your child.
For this reason, it is crucial to harmonize your beneficiary designations, property titles, and estate planning documents to help your estate avoid costly lawsuits after your death.
7. Naming your estate as beneficiary
An “estate” generally refers to your probate estate, meaning assets that are subject to probate. So if you list your estate as the beneficiary of a life insurance policy, then those proceeds will need to be probated after your death.
Designating your estate has beneficiary can have even greater consequences when dealing with retirement assets such as an Individual Retirement Account (IRA).
In the case of an estate-beneficiary, there are only two distribution options for an IRA:
Distribute as a lump sum, which is fully taxable at that time; or
Distribute within five years of the decedent’s death, with each payment being taxable at the time of distribution.
On the other hand, a spousal beneficiary can roll over retirement proceeds into their own IRA and take required minimum distributions (RMDs) based on their age rather than the decedent’s age.
Non-spouses can select a similarly tax-advantageous option: a non-spousal beneficiary can set up an inherited IRA (also known as a “stretch IRA”) and take annual distributions over a longer period of time.
The rules here can be tricky, so you should speak with a financial advisor about your particular account or policy and, in any case, review estate planning options with an attorney.
Review beneficiary designations
Naming a POD beneficiary is an excellent way to avoid probate. However, it is not without its share of risks and potential problems. Because beneficiary designations supersede the provisions of a will, they should be carefully reviewed with an attorney and coordinated with your estate planning documents.
To speak with an attorney about beneficiary designations and other estate planning techniques, contact the experienced Oklahoma City estate planning attorneys at Postic & Bates for a free, no-obligation consultation appointment.
David M. Postic is an associate attorney at Postic & Bates, P.C. His practice includes estate planning, probate, real estate, adoption, business law, and litigation.
You can email David through our Contact Us page or by calling our office at (405) 691-5080.
[As with all our posts, the contents of this article do not constitute legal advice and are subject to our site-wide disclaimer.]