Why Is Beneficiary Designation Important?

POSTED ON: June 18, 2022

When you set up your estate plan it is important to coordinate the legal planning documents that you or you and your attorney create with the document provided by your retirement account custodian and/or your life insurance carrier called a ‘Designation of Beneficiary.’

Why Is Beneficiary Designation Important?

The beneficiary designation will always supersede language of your will. Neglecting to know which assets have beneficiary designations and failing to update the designations can undo even the best estate plan.

The beneficiary designation for your life insurance, annuity, or retirement account custodian provides an opportunity to tell the company who is to receive life insurance proceeds, annuity, or retirement savings upon your death, explains a recent article titled “This Important Estate Planning Step is Often Missed” from Coeur d’Alene/Post Falls Press. If these are not coordinated with a last will and testament, the results are problematic at best, and worse, financially, and emotionally devastating.

This epic fail comes in many different forms, but the most common is when a life insurance policy has never been updated and an ex-spouse receives the policy proceeds. The rules differ between retirement accounts and life insurance and can be impacted by various state and federal laws (and the divorce decree, if the life insurance policy was included). However, for the most part, the ex will receive the proceeds and litigation will not succeed.  This is because the beneficiary designation is a contact between you and the insurance company or retirement custodian.  They are required by contract to pay to the person named in the beneficiary designation, and this is why such proceeds to not go through probate.

Occassionally, a person will die without having named a beneficary.  This most often occurs when a person named a spouse as beneficiary, but that spouse died and a contingent beneficiary was not named.  In such a case, the proceeds must by law be paid to the estate, and in this case the funds do go through probate.  This can be problematic for two reasons. First, life insurance and retirement accounts are “asset protected” under federal and/or state law.  However, if the funds go through probate, the creditors of the estate will have a chance to get the assets.

Example.  Bill has a life insurance policy.  He named his wife as beneficiary of the policy and did not name a contingent beneficiary.  His wife died last year and Bill has not updated the beneficiary designation. Bill dies in a car accident in which he was at fault.  Bill’s estate is liable to the “injured person” for damages and a personal injury attorney is hired by the “injured person” to extract as much wealth from Bill’s estate as possible.  Normally, if Bill had named a beneficiary, the life insurance proceeds would be go directly to the beneficiary and would be protected.  However, because Bill’s beneficiary designation lapsed (he did not have a beneficiary), the policy proceeds are payable to Bill’s estate, and the “injured person” can make a claim on the policy proceeds that are funneled through the estate.

Another common beneficiary designation mistake is when a person has created a living trust or revocable trust to prevent assets from going through probate when they die. Probate can take many months to complete and there are several strategies used to take assets out of the probate estate.

When the living trust is established and assets are transferred into the trust, those assets do not pass through probate.

However, if a person (or married couple) established a living trust and fails to list both primary and secondary beneficiaries for life insurance and/or retirement accounts, it is entirely possible that the assets will go through probate.  In such a case, the person should name the trust as the beneficiary of the policy.  This can protect the assets even if paid out to the trust depending on the asset protection features of the trust (for example, if the trust is an irrevocable trust).  If done incorrectly, payouts of life insurance policies can have a significant impact on Medicaid long-term care planning as well.

Take the time to make an inventory of all assets and accounts. Determine which ones have a beneficiary designation and find out who is named as the beneficiary. If your retirement accounts and life insurance policies were established decades ago, this is especially important.

Failing to coordinate beneficiary designations with your estate plan could undermine your wishes. Review these items with your estate planning attorney to avoid these and many other potential pitfalls.

BOOK A CALL with me, Ted Vicknair, Board Certified Estate Planning and Administration Specialist, Board Certified Tax Law Specialist, and CPA to learn more about estate planning, incapacity planning, and asset protection.

If you liked this article, “Why Is Beneficiary Designation Important?” read also these additional articles: Does Diabetes Increase Chances of Suffering from Dementia? and Protecting Your House from Medicaid Estate Recovery and How Do I Plan for Taxes after Death? and How to Find a Great Estate Planning Attorney

Reference: Coeur d’Alene/Post Falls Press (May 23, 2022) “This Important Estate Planning Step is Often Missed”

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