Who You Choose Can Have Important Ramifications.
Loren M. Lopin, Trusts & Estates, P.C.
Typically, a married person names their spouse as the beneficiary of their retirement account (401(k), IRA, 403(b) etc.) or life insurance policy. Children are often named as the contingent beneficiaries. If a person is single but has children, that person’s children are often named as first beneficiaries. However, retirement accounts and life insurance policies often end up in California probate court because of mistakes people make in naming beneficiaries.
Common mistakes include the following:
Failure to Name a Contingent Beneficiary
Many people only name one person as the beneficiary of their retirement accounts and life insurance policy. However, if you outlive your designated beneficiary, both your retirement accounts and life insurance policy will be subject to probate. The failure to name a contingent beneficiary will result in the policy proceeds and retirement accounts being used for probate proceedings and attorney fees instead of going directly to your beneficiaries.
Further, the unintended consequence of the probate may be that the ultimate beneficiary of the life insurance policy and retirement accounts are distant heirs whom you would never have wanted to inherit your assets. Therefore, it is important to always name contingent beneficiaries and periodically update your beneficiary designations on both retirement accounts and life insurance policies.
Naming a Minor as a Beneficiary
Parents often buy life insurance to provide for their children in case they die before the children are grown and have finished school. However, naming minor children on either a life insurance policy or retirement account is a mistake. Naming a minor as the beneficiary will subject both the life insurance policy and retirement accounts to probate court and require a court-ordered guardianship of the estate for the minor child. A guardianship of the estate for the minor child will result in thousands of dollars being expended in court and attorney fees and bi-annual accountings to the probate court.
Further, when the child turns 18 years old, the child will receive the proceeds from both the life insurance policy and retirement accounts. Most 18- year-olds are not yet mature enough to manage a large amount of money and may not use the money as their deceased parents intended. However, by leaving the proceeds of the life insurance policy in a Trust and naming the Trust as the primary or secondary beneficiary of retirement accounts, then the minor child is protected. This allows the policy holder to control how the life insurance policy proceeds are used, and sets the age the beneficiary has access to the proceeds from both life insurance and retirement accounts without probate court supervision.
Naming a Beneficiary Who Receives Government Benefits
Naming a person with special needs who receives needs-based government benefits as the beneficiary of a retirement account or life insurance policy may cause the beneficiary to lose their government benefits. If your desire is to provide for a special needs person, setting up a special needs Trust and naming the special needs Trust as the beneficiary of both life insurance policies and retirement accounts can protect these assets for the beneficiary. The proceeds in the special needs Trust are used to supplement the government benefits instead of eliminating them, which would happen if a special needs Trust was not established.
Assuming a Trust Controls Both a Retirement Account Beneficiary Designation and a Life Insurance Policy Designation
People setting up Trusts often assume that their estate plan, including the distribution of retirement accounts and life insurance policies are automatically controlled by their Trust. This assumption is wrong. The retirement account beneficiary designation and life insurance policy beneficiary designation control where the monies are distributed, not the Trust. To ensure that both retirement account and life insurance proceeds become part of the Trust, the Trust needs to be named the primary or secondary beneficiary of both retirement accounts and life insurance policies.
To avoid these common mistakes and an unintended probate, it is important to periodically review your beneficiary designations on both retirement accounts and life insurance policies. Important life events that trigger the need for review of your beneficiary designations include births, deaths, divorces, and significant changes in your assets.
Contact me if you have any further questions about beneficiary designations on retirement accounts and life insurance policies.