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– Guest Blog –

Beneficiary Designation Blunders:

Mistakes and Misconceptions

Written By: Michael D. Kaiser, Attorney, Kaiser Holahan, LLC

The term estate planning brings to mind words such as will, trust, probate, and attorney. However, one of the most powerful tools in estate planning – the beneficiary designation – often is overlooked or misused. Unlike a will or trust drawn up by an attorney, the beneficiary designation can be casually placed before you by a banker, a financial advisor, or an employer as you start a new job. How are you supposed to fill out those forms? Whose names to put where? When should they be changed or reviewed? Designating your beneficiaries correctly is critical to an effective estate plan. Here are a few scenarios to consider and perhaps lead you to revisit your designations.

Just because you can doesn’t mean you should

Sally’s banker suggests that she simply list her three children as POD (Payable On Death) on all accounts. Her banker says: “You know, if you just list the three of them, we will just close the account and split the money when you die.” So, Sally signs the forms at the bank and does the same with all her accounts—life insurance, IRA, and her mutual fund account. However, her house still is in her name when she dies. The eldest daughter, Susy, is the named executor in Sally’s will, and needs to open probate because the house remains in Sally’s name. As Personal Representative, Susy is responsible for maintaining the house until it’s sold; the furnace needs repairs, the snowplow guy needs to be paid to keep the drive clear while the house is being shown, the real estate tax bill is due, she wants to hire an attorney to help her, and she has mom’s taxes to file. Because of the POD designations, there is no cash available to the estate for these expenses. One sister has already spent her “share” of the POD funds and Susy’s brother is not speaking to her after a feud over funeral arrangements. Susy can use her one-third share of the POD funds to cover expenses until the house sells, but is that what their mom wanted? Is that fair to Susy? Can she get her money back with interest when the house sells? What if it takes six months or more to sell the house?

Funding the trust is not exactly “set it and forget it”

Judy, whose husband died about six years ago, has a trust that was designed to help her avoid probate and was intended to hold the inheritance of her then-young kids if both parents died. Her children now are adults ages 45 and 47. Under the trust provisions, they are to receive all the funds if they are more than age 25 at the time of Judy’s death. However, after Judy dies, it becomes apparent that her estate wasn’t all in order as she and her husband thought it was. When her husband died, Judy worked with an advisor to roll her husband’s IRA into her own IRA, believing that was all she needed to do. Her IRA had been set up long ago and listed first her now-deceased spouse, then the trust as beneficiary. She never updated that beneficiary designation after her husband died. Now at her death, the firm holding the IRA wants to pay out the entire IRA account to the trust as an income-taxable event rather than having each child receive half in an inherited IRA with the ability to further defer the income tax. Her children end up paying an attorney to guide them through this mess. Had Judy simply updated the beneficiaries to list her children directly, her financial advisor could have simply set up an inherited IRA for each child and rolled the funds over, providing each child with options as to how and when to withdraw these inherited IRA funds.

The attorney also had advised Judy to make her bank accounts payable on death (POD) to the trust, which she did. However, she recently had moved her banking to a credit union that had a better rate on CDs. The new accounts are in her name only with no beneficiary listed—she didn’t realize that the POD designation would not transfer from her former bank to the new credit union and the employees there never asked her or offered that option. With a total of $85,000 at that credit union at time of her death, her family now will have to open a probate estate to move that money to her trust, resulting in additional legal fees, probate fees, and public notice of the probate—exactly what Judy was trying to avoid.

Simple solution turned unintended windfall (or worse)

Jack, an elderly single man, had a house, small banking account, IRA, and a small life insurance policy. He had worked with his attorney four years earlier to designate beneficiaries for his assets and to put his house into a trust. When Jack’s health began to fail, his banker suggested he list his eldest son, Jack Jr., as beneficiary of his everyday checking account so the son could have access to funds when Jack Sr. died in order to pay for funeral, burial, and other expenses. Jack Sr. trusted Jack Jr. completely and followed the banker’s advice. Jack Sr. had kept about $15,000 in that account and Jack Jr. lived right down the street; in fact, he was the one helping to care for his dad. Jack Sr. had named his daughter, Emma, as executor/personal representative in his will when he updated it four years ago.

Ultimately, Jack Jr. moved his dad to a nursing home when his care could no longer be managed at home. At his dad’s direction, Jr. sold the house, and the funds were wired to Jack Sr.’s checking account. Jack Jr. had arranged with his father’s financial advisor to invest those monies for his dad’s benefit after the home sale was closed. All went just as planned, except that the day after the closing, Jack Sr. died unexpectedly. The checking account now had $300,000 in it.

Consider the resulting complications with each of the following situations:

– Jack Jr. is in the middle of a bankruptcy, with creditors swirling.

– Jack Jr.’s wife files for divorce a week later.

– Jack Jr. dies a week after claiming the funds and moving them to his bank account.

– Jack Jr. and his sister, Emma, don’t get along quite as well as Jack Sr. had thought. They can’t agree on anything and after the funeral, won’t answer each other’s phone calls. Who gets the $300,000?

– All goes exactly as planned. Jack Jr. claims the $300,000 in the account as the named beneficiary. He pays for everything just as he and his dad had discussed. He has $250,000 left and cuts a check for half to his sister. Jack Jr. just made a taxable gift to his sister and needs to report that gift on a gift tax return—and it may impact the estate taxes Jack Jr.’s estate may bear at Jr.’s death.

The lessons in these scenarios? How your accounts are titled and how your beneficiaries are designated are critical choices. While these examples may seem extreme, they highlight the critical need to get this right and review regularly.

To help ensure your loved ones are protected and your assets are distributed according to your wishes, contact your financial advisor and/or your estate planning attorney to review all of your designations. Do it today!