A client we’ll call Mark (not his real name) opened an IRA account when he was a young, single professional. Because he was young and single, he listed his parents as beneficiaries. Over time, his circumstances changed, including marriage and children. He subsequently went to work for a large corporation that offered a 401(k) and other benefits, which Mark took advantage of. The IRA account became inactive, but remained open. Sadly, Mark passed away unexpectedly while his children were still living at home. His will called for his widow to receive ownership of all his assets, which she did—except for the IRA which, by this time, even though no deposits had been made for a number of years, had enjoyed significant appreciation in value. However, because Mark’s parents were still the designated beneficiaries, those assets went to the parents rather than Mark’s widow and his children, as Mark would have intended.
Situations like this occur all too frequently. Most estate planning attorneys can tell story after story of having to tell a bereaved spouse, a cherished sibling, or the director of a charitable organization that, rather than receiving assets to which they would have otherwise been entitled, those assets—a retirement account, a life insurance policy, or an annuity—will go to someone else that the deceased person would not likely have preferred, simply because a beneficiary designation was never updated.
We’ve written previously about the importance of verifying beneficiary designations as part of keeping an estate plan updated. The process is usually as simple as filing a form, either written or online, with the plan provider. However, this simple step is often overlooked. An old IRA account, a life insurance policy purchased years ago, and other important financial assets that require beneficiary designations can often fall into the “memory hole” until the assets become payable to persons or entities that do not align with the original account holder’s wishes. What many may not realize is that beneficiary designations supersede the terms of wills and trusts, which means that such misalignment can do serious damage to even the most carefully crafted estate plan.
Staying up to Date
For this reason, reviewing the beneficiary designations on accounts like those mentioned above and also for certain pensions and other sources of income should be a regularly scheduled activity. The fact is that change is the only constant. People marry, get divorced, have children, experience the death of family members, buy businesses, sell businesses, and undergo many other types of changes in their lives that have implications for how they want their assets to be apportioned upon their deaths. The only way to be sure that your beneficiary designations will function in accordance with the rest of your estate plan is to look at them periodically to make sure they match up with your current circumstances. In fact, this should be a regular part of your periodic estate plan review.
Trusts as Beneficiaries
Some persons seek to avoid unintended consequences in their estate planning by making a trust the beneficiary of insurance policies, retirement accounts, etc. However, account holders will still need to exercise some care and attention to detail in order to make sure that the trust is properly designed to ensure that their wishes are carried out in the most effective way for all concerned.
Why would someone want to designate a trust as beneficiary, instead of just designating a spouse, child, or other person? Several reasons can apply to this decision. Perhaps the most important is protection against a spendthrift beneficiary. For example, the creator of the trust may want to be sure that a grandchild does not use up all the assets before a certain age; the trust can be structured to disburse assets in accordance with this wish. Another reason might involve the grantor’s wish to provide both for a current spouse and children of a previous marriage. A trust can stipulate that the spouse may receive income from the trust and also provide an inheritance for the children.
It’s important to understand is that if the beneficiary of a retirement account is not a natural person, the payout of assets from the account may become subject to a five-year limitation if the account holder dies before the required beginning date (RBD) for distributions. When this happens in the case of a non-person beneficiary, the IRS may disallow use of the deceased account holder’s life expectancy for calculating the annual required minimum distribution (RMD) and require the assets to be disbursed over no more than a five-year period.
To avoid creating unforeseen or undesired complications for beneficiaries, care should be taken in using trusts as recipients of retirement accounts. For one thing, the account holder should check with the retirement account custodian to make sure that the provisions of the trust do not conflict with the plan documents and that they pass regulatory muster. As mentioned above, care must be exercised to ensure that, upon the account holder’s death, the appropriate documentation is submitted to the IRS by the October deadline; otherwise, the RMD will revert to the five-year minimum term. The trust should be structured so that it cannot disclaim the assets of the plan. When assets are disclaimed, the proceeds may become payable to a primary or contingent beneficiary, and the trust is nullified. This can be avoided by including in the trust documents what is commonly called a “disclaimer provision” that specifies disposition of the assets in accordance with certain trust provisions. Another problem can arise when certain provisions of a trust are in conflict with the retirement plan document. To avoid these and other potential pitfalls, the account holder should consult with a qualified attorney and tax professional, who can help insure that the documents are properly designed to satisfy the account holder’s requirements.
At The Planning Center, we work with clients who place a high priority on ensuring that their estate plans efficiently support their most important priorities. To learn more, please visit our website and read our article, “Settling a Loved One’s Estate: Some Basic Information.”
