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Beware Beneficiary Designations – Massachusetts Estate Planning

By Harry S. Margolis


One of the ironies of estate planning is that while there’s a long history of cases and laws around wills and their execution requires the formality of two witnesses and a notary public, most property passes to heirs through other, less formal means.

Many bank and investments accounts, as well as real estate, have joint owners who take ownership automatically at the death of the primary owner. Other banks and investment companies offer the option payable on death accounts which permit owners to name the person or people who will receive them when the owners die. Life insurance, of course, permits the owner to name beneficiaries, as do retirement accounts.

Absence of Formality Can Lead to Inconsistency

All these types of ownership and beneficiary designations permit these accounts and types of property to avoid probate, meaning that they will not be governed by the terms of a will. Usually, in contrast to the formal requirements of a will, these beneficiary designations can be put into effect with a simple signature or even online with simple access through a username and password. When taking advantage of these simplified procedures, owners need to be sure that the decisions they make are consistent with their overall estate planning. It’s not unusual to see a will that directs that the decedent’s estate be equally divided among her children, but to find that through joint accounts or beneficiary designations that the estate is distributed totally unequally, or even to non-family members, such as new boyfriends and girlfriends.

It’s also important to review beneficiary designations every few years to make sure they are correct. We’ve also seen property passing to ex-spouses (not that one can’t care about one’s ex-spouse), ex-girlfriends and boyfriends, and to people who passed away before the owner. All of these can totally screw up an estate plan and leave a legacy of resentment that most people would prefer to avoid.

Be Really Careful with Retirement Plans

All of these concerns are heightened when dealing with retirement plans—whether IRAs, SEPs, or 401(k) plans—because the choice of beneficiary can have significant tax implications. These types of retirement plans benefit from deferred taxation in that the income deposited into them as well as the earnings on the investments are not taxed until the funds are withdrawn. In addition, owners may withdraw funds based more or less on their life expectancy, so the younger the owner, the smaller the annual required distribution. (Click this link to see the IRS withdrawal table.) Further, in most cases, withdrawals do not have to begin until after the owner reaches age 72 (70 1/2 if they were born before July 1, 1949). However, this is not always the case for inherited IRAs.

Following are some of the rules and concerns when planning for retirement accounts:

  • Name your spouse, usually. Surviving husbands and wives may roll-over retirement plans inherited from their spouses into their own plans. This means that they can defer withdrawals until after they reach age 72 (70 1/2 if they were born before July 1, 1949) and take minimum distributions based on their own age. (This chart indicates IRS life expectancies after age 70 1/2.) Most non-spouses of retirement plans must begin must withdraw their inherited IRA by the end of the 10th year after the original owner’s death.
  • But not always. There are a few reasons you might not want to name your spouse, including:
    • He or she is incapacitated and can’t manage the account.
    • Doing so would add to his or her taxable estate.
    • You are in a second marriage and want the investments to benefit your first family.
    • Your children need the money more than your spouse.
  • Consider a trust. In a number of these instances, a trust can solve the problem, providing for management in the case of an incapacitated spouse, permitting assets to benefit a surviving spouse while being preserved for the next generation, and providing estate tax planning opportunities. Often (infirst marriages) we recommend that clients name their spouse as the primary beneficiary and a trust as the secondary, or contingent, beneficiary. This permits the surviving spouse, or his agent if he’s incapacitated, to refuse some or all of the inheritance through a “disclaimer” so it will pass to the trust. Known as “post mortem” estate planning, this approach permits flexibility to respond to the “facts on the ground” after the death of the first spouse.
  • But check the trust. Most trusts are not designed to accept retirement fund assets. If they are missing key provisions, they might not be treated as “designated beneficiaries” for retirement plan purposes. In such cases, rather than being able to stretch out distributions during the beneficiary’s lifetime, the IRA or 401(k) will have to be liquidated within five years of the decedent’s death, resulting in accelerated taxation.
  • Be careful with charities. While there are some tax benefits to naming charities as beneficiaries of retirement plans, if a charity is a partial beneficiary of an account or of a trust, the other beneficiaries may not be able to stretch the distributions during their life expectancies and will have to withdraw the funds and pay the taxes within five years of the owner’s death. One solution is to dedicate some retirement plans exclusively to charities and others to family members.
  • Consider special needs planning. It can be unfortunate if retirement plans pass to individuals with special needs who cannot manage the accounts or who may lose vital public benefits as a result of receiving the funds. This can be resolved by naming a special needs trust as the beneficiary of the funds, though this gets a bit more complicated than most trusts designed to receive retirement funds. (It needs to be an “accumulation” trust rather than a “conduit” trust, in case you were wondering.) Another alternative is not to name the individual with special needs or his trust as beneficiary, but to make up the difference with other assets of the estate or through life insurance.
  • Keep copies of your beneficiary designation forms. Don’t count on your retirement plan administrator to maintain records of your beneficiary designations, especially if it’s connected with a company you worked with in the past, which may or may not still exist upon your death. Keep copies of all of your forms and provide your estate planning attorney with a copy to keep with your estate plan.
  • But name beneficiaries! The biggest mistake many people make is not to name beneficiaries at all or they end up in this position by not updating their plan after the originally-named beneficiary passes away. This means that the plan will have to go through probate at some expense and delay and that the funds will have to be withdrawn and taxes paid within five years of the owners death.

In short, while wills are important, in large part because they name a personal representative to take charge of your estate and they name guardians for minor children, they are only a small part of the picture. A comprehensive plan needs to include consideration of beneficiary designations, especially those for retirement plans.

Related content:

4 Steps to Protect Your Digital Estate

Why You Don’t Need to Review Your Estate Plan Every Five Years (Unless You’re Over 60)

Why We Don’t Plan: Prunes

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