When your will and trust are not enough.
It’s awkward. And complicated. And emotional. But dealing with what happens to your estate after your death is an unavoidable and essential task. Like many people, you may have consulted an estate attorney to create a trust and will, ensuring that assets pass along to selected family, friends or institutions. However, like many people, you may not realize there is another step to take. A step that, if missed, could mean your wishes are not followed or your beneficiaries pay more taxes or wait longer to have access to their inheritance.
The Crucial Step
Many people do not realize that the beneficiary listed on an account takes precedence over those named in a will or trust.
That is, regardless of who is named on your will and trust, those wishes have no bearing on accounts that have a different beneficiary designated.
As an example, imagine that your uncle goes through a terrible divorce but then meets the woman of his dreams and gets remarried. Being a responsible person, Uncle Charles revises his will and trust naming his new wife as his beneficiary. However, he neglects to update his beneficiary designation on his life insurance policy and his IRAs. When he passes away unexpectedly, his insurance and IRA benefits are paid out to his ex-wife while his new wife receives nothing, even though she’s listed in the will and trust.
As another example, let’s say that you and your spouse created a will and trust that equally distributes your $5 million insurance policy among your four children. However, unfortunately, you had not updated the policy beneficiary designations between the births of your second and third children, listing only the older two by name. Since the beneficiary designation on the account takes precedence over the will and trust, only your oldest two children would receive any inheritance from the policy. The younger two children would receive nothing, which would likely create conflict and drama at an already emotional time.
What if there is no beneficiary listed on an account?
If there is no beneficiary designation on an account, the will or trust will be consulted. However, if there is no beneficiary designation and no will or trust, a court determines your beneficiaries for you.
Even if you have a will or trust to turn to in the case that an account has no beneficiary designated, there can be tax implications for the heir. For example, some accounts must be paid out within five years of death, like annuities, qualified plans and IRAs. A named beneficiary can rollover to a qualified plan or stretch out their withdrawals from the IRA over the rest of their lives, deferring their income taxes. If the beneficiary is named by the will or trust or determined by a court, the funds must be drawn out during a five-year period or possibly even taken out as a lump sum distribution, both of which would be taxed at a much higher tax rate than funds rolled into a qualified plan.
What should you do next?
First, review your estate plan and ownership of your assets. Consider whether your trust should be the beneficiary rather than specific people’s names. Listing your trust has two main benefits:
- Avoiding probate, which means avoiding additional costs and delays in transferring assets.
- Achieving balance when distributing inheritance among heirs.
For example, let’s say you have a $2 million qualified plan that you are leaving to your son. To be fair, you leave the rest of your estate, also worth two million dollars, to your daughter. You feel that you’ve balanced the inheritance perfectly and that both your children will receive equal shares. However, because your son is named, he can take the assets out of the account throughout his life, paying a much lower tax rate. While your daughter, unfortunately, may be required to pay the entire inheritance tax, which is at a much higher rate. While you intended to be fair, tax implications of the various kinds of inheritance leave your son with a much larger amount than your daughter. Naming your trust as the beneficiary and then designating inheritance within the trust will allow you to achieve the balance you desire.
Second, check the following list of accounts to be sure your designated beneficiaries are up to date:
- Any kind of retirement plan offered by an employer
- Life insurance policies
- Mutual funds
- Bank accounts
- Brokerage accounts
- 529 college savings plans
- Will and trust documents
- Qualified plan
- Anything else that has designated beneficiaries
When should you update your beneficiaries?
Some experts suggest checking your beneficiaries annually; others suggest every three to five years. One easy way to remember which accounts to check is to gather the 1099 tax forms from the financial institutions holding your assets, which you should receive in February of each year.
You should also update your beneficiaries any time there is a major change in your life, including:
- Marriage, divorce or remarriage
- Job change
- Rolling a retirement plan into an IRA
- Death in the family, especially if your primary beneficiary dies. Even if you have a secondary beneficiary listed, you need to name a new secondary beneficiary.
- Your financial institution changes ownership
- You have a child or a grandchild
How do you check who is listed as your beneficiaries?
Simply call your financial institution or see if you can access the information through your online account. Typically, the only information you need to provide about your beneficiary is their name and address, although sometimes a social security number is also required.
While thinking about what happens to your assets after your death can feel overwhelming, awkward and emotional, taking the time to update your beneficiaries prevents animosity and expense for your beneficiaries after your death. If you have any questions about trusts, wills or beneficiary designations, contact us today.