Review and Update Beneficiary Arrangements

Beneficiary Designations Trump the Provisions of a Will or Trust

Beneficiary designations at death trump the provisions of a will or trust. Regardless of the planning that has been done for distribution of the estate, if there is a designated beneficiary or beneficiaries, that person or persons will receive the asset at death. These provisions have routinely been challenged in court. No court, if the beneficiary and the contract were legal, has overturned distribution to a beneficiary.

Those individuals who create their own wills may not be aware of this pitfall. They may think that the will governs distribution. They may fail to update beneficiaries on those contracts that require it and an undesired distribution may take place. In addition, attorneys will often set up living trusts with a pour over provision at death to a will. Oftentimes, the attorney will fail to follow up on instructions to his clients to change beneficiary arrangements from individuals to the trust as beneficiary. The clients may have forgotten or not be aware of this important step. At death, the money will go to the wrong beneficiaries and not end up in the will.

Remember, in community property states, regardless of the beneficiary designation, a property that was acquired while the couple was married is considered jointly owned. The beneficiary may be forced to turn over a portion of the asset to satisfy this requirement. The surviving spouse always has claim against 50% of the asset regardless of the beneficiary. In common law states, if the surviving spouse does not get at least a statutory allotment of the assets at death, the spouse can petition the court to receive his or her elective share under the law.

Joint Ownership with Rights of Survivorship

Property owned jointly with rights of survivorship is treated very much like property owned with multiple beneficiaries. The difference is often in the distribution to remaining owners if one has died. Unless percentage ownership of specific shares is spelled out, which is not always allowed in all states, only the surviving owners will inherit the property. Any who have died are left out. On the other hand, with beneficiary designations, beneficiaries who have died, without listing any surviving beneficiaries, will result in probate and distribution according to state intestacy laws. This would result in statute determined distribution to wife and children first, then to parents, then to siblings and so on.

Joint ownership also is fraught with danger if one of the owners ends up in divorce, has creditors who are in pursuit or ends up in a lawsuit with a judgment. The divorced partner may end up with a court ordered share that was not intended for that person to have. Having someone on the title adversarial to the other owners' interests could cause all kinds of problems. The ownership portion of the property for someone who has creditors or has a judgment is subject to lien.

Changing Beneficiaries after Divorce or Death

Here is an example that shows the importance of reviewing and updating beneficiaries after divorce.

The recent United States Supreme Court case, Kennedy v. Plan Administrator for DuPont Savings and Investment Plan, 497 F.3d 426 (2009), highlights how critical it is to keep your beneficiary designations up to date.

William Kennedy participated in his employer's pension plan. In 1971 William married Liv and in 1974, William updated his beneficiary designation to name Liv as beneficiary of his pension. William did not name a contingent beneficiary. In 1994 the couple divorced. Under the terms of the divorce decree, Liv waived all rights to the pension. After the divorce, William updated beneficiary designations on other assets to name his daughter as beneficiary, but he neglected to update the beneficiary designation on his pension.

Upon his death, Williams daughter, Kari was appointed as executor of his estate. Kari requested that the administrator of the pension deliver the funds to her, but the pension administrator refused and instead issued the funds to Liv in accordance with the beneficiary designation. The Supreme Court upheld the pension adminsitrator's actions despite the waiver of rights contained in the divorce decree. The Court did indicate that a Qualified Domestic Relations Order (QDRO) would have been effective in eliminating the spouse's rights. Nonetheless, this decision indicates the weight of importance placed on beneficiary designations and highlights the need to keep designations up to date as part of your comprehensive estate plan.

Here is another example of the need for updating.

One of the most poignant examples of this mistake comes out in a New York Post story back in 2001. The story "Pension Pickle!" tells a twisted tail of Anne Friedman's nearly million-dollar pension. Anne was a lifelong New York City school system employee. In 1974, Anne named her mother, uncle and sister on her beneficiary form with the Teachers' Retirement System. A year later, Ann met and married Bruce Friedman to whom she was happily married for the next two decades.

During her entire marriage, Anne never updated her beneficiary designation. So after her death, Anne's sister was the sole surviving beneficiary of Anne's retirement plan and only her sister had the right to receive Anne's pension money. Anne's sister exercised her right, took nearly a million dollars of Ann's pension and left Bruce with nothing. Bruce sued, lost, appealed and lost.

Contingent Beneficiaries

This article is courtesy of Paul Katz who is a member of the New York State Society of CPAs' Risk Management and Business Insurance Committee. Policy holders should also name a secondary, contingent beneficiary, who will provide a "contingency" if the primary beneficiary dies before the insured or annuitant. Naming a contingent beneficiary prevents the proceeds of the policy from going into the estate of the insured or annuitant if the primary beneficiary predeceases them, which could cause probate action, increase estate costs, and delay the proceeds from reaching the intended individuals.

Policy holders need to pay special attention to the wording of beneficiary designations to ensure that benefits go to the right person or entity. A birth or adoption of a child, a change in partnership (or corporate) interests, a marriage or divorce can all affect the original choice of who will receive the death benefit. For example, if "wife (or husband) of the insured" is written, without specifying a specific name, an ex-spouse (or even ex-partner) could receive the proceeds. On the other hand, if specific children are named as primary or contingent beneficiaries, any later-born or adopted children will not receive any proceeds.

It is especially important with assets such as life insurance or deferred annuities that the contingent beneficiaries and their survivors are assigned their portion of the distribution. If the share of each beneficiary is not spelled out, either the insurance company will determine distribution share based on the contract or it will revert to state intestacy laws. Many times, the distribution share to contingent beneficiaries and their survivors is not what the owner of the policy wanted.

Review of Beneficiaries on IRA Accounts, 401(k)s and Other Retirement Accounts

Distribution rules for IRA accounts are extremely complicated. Not only are these rules difficult to understand for the living owner of an IRA but they just as confusing at the death of the owner. There are certain tax advantages to setting up beneficiaries correctly, especially non-spouse beneficiaries who would inherit the IRA at death. It is extremely important to make sure that the beneficiary arrangements are set up properly.

If a beneficiary has died or if there is no beneficiary, then the IRA must go through the probate court. Depending on who will inherit the proceeds, probate may force distribution before the end of five years from death. The lenient distribution rules available to the spouse or surviving children will be lost. This might result in an unwanted tax burden. IRA distributions will be discussed in further detail in the section on taxes. Here is a checklist of what a life resource planner would look for in reviewing IRA beneficiaries.

• Make certain the client understands the IRA definition of "designated beneficiary" as it applies to Individual Retirement Accounts so the client is aware of the stretch option opportunity.
• Obtain from the client a copy of the beneficiary designation form for every Individual Retirement Account or employee sponsored retirement account owned. (Bank, Credit Union, Mutual Funds, Brokerage Account or Annuity.)
• Make certain that a primary and a secondary (contingent) beneficiary is named.
• If there are multiple beneficiaries that each beneficiary's share is clearly identified with a fraction, a percentage, or the word "equally", if that is applicable.
• Make certain that the financial institution has the beneficiary selection on file and that their records agree with those of the client (Financial institutions merge, move and quit business).
• Have the client keep a copy of all the beneficiary designation forms and provide copies to relevant advisors.
• Request that clients let someone know where to locate the beneficiary designation forms upon their death.
• Review the beneficiary designation forms with the client on an ongoing basis to make sure theforms are correct and reflect any changes that occur during the year to new tax laws, such as increases or decreases in the estate tax exemption, the client's own estate planning, and to major life events such as birth, death, adoption, marriage, divorce or remarriage.
• Explain the potential pitfalls of naming an unexamined revocable living trust as an IRA beneficiary when the client intends to use the stretch option.
• Analysis whether a Roth IRA conversion is the right decision for the client or not.