Overuse of Beneficiary Designations Can Derail a Client’s Estate Plan

by: Sol S. Reifer, JD, LL.M – Estate Planning, Accredited Estate Planner
“I notice that your account does not have a beneficiary listed, would you like to list one now? Listing a beneficiary can avoid the expense and delay of probate.”

This is a question more and more of our clients are being asked (and encouraged to prepare) by representatives at financial institutions. However, for many of our clients – who have a comprehensive estate plan – naming a beneficiary on non-retirement accounts can, unbeknownst to the client, result in the unintended consequence of derailing the entire estate plan.

Typically, clients understand that retirement accounts and life insurance policies pass to beneficiaries as a result of the beneficiary designation forms completed when a retirement account is opened or an insurance policy is obtained. During the estate planning process, these beneficiary designations are reviewed to ensure that the beneficiaries are correct and that the distribution of these assets conforms with the client’s intended estate plan. The beneficiary designations on these types of accounts are often carefully tailored to allow the assets to pass through to trusts created under the client’s estate planning documents, affording a variety of benefits through this advanced estate planning technique. The beneficiary designations on these types of accounts also allow the assets to avoid probate after death.

Separate and apart from the beneficiary designations on retirement accounts and life insurance policies, a Transfer on Death (“TOD”) or Payable on Death (“POD”) designation can be set up for a checking, savings, certificate of deposit, U.S. savings bond or investment account. It is simple in concept and practice: upon the death of the account holder (i.e., the client) the funds pass directly to the named beneficiary. As a result, however, the assets do not pass under the client’s estate planning documents, thereby possibly defeating the intended tax planning and distribution scheme provided for in these documents.

Unfortunately, when it comes to non-retirement accounts, the effect of naming beneficiaries is usually not adequately explained to the client, and the financial representatives asking the question generally focus only on probate avoidance. Since many clients believe avoiding probate at all costs is a good thing, they will readily designate beneficiaries to any type of account for that reason alone, not understanding the potential repercussions. Estate planning professionals need to be aware of the increasing prevalence of this practice and advise clients accordingly.

Possible Unintended Consequences

Loss of tax savings strategies. Assets passing directly to beneficiaries do not pass under the client’s estate planning documents. If the client’s plan utilizes funding formulas to optimize tax savings by way of a credit shelter trust, marital trust or generation-skipping trust, the assets are not available to fund such trusts and tax planning strategies may not be utilized to their full potential, resulting in an inefficient use of the client’s applicable exemptions and the potential loss of significant tax savings.

Unintentional beneficiary exclusion. If all or a significant portion of assets pass directly to beneficiaries, there may be insufficient assets to satisfy bequests to individuals and fund trusts under the client’s estate planning documents.

Loss of creditor protection / asset management. Many estate plans utilize trusts to protect assets against creditor claims of a beneficiary or to provide asset management for a beneficiary. If the assets pass directly to the beneficiary, any ability to provide creditor protection for the beneficiary and control asset management will be lost.

Estate administration issues. If a significant portion of the client’s assets pass directly to beneficiaries, the administration of the estate, including payment of taxes, debts and expenses, may be complicated by a lack of funds under the control of the fiduciary. If estate tax is due, the beneficiary of an account will be liable for paying the proportionate share of any such tax.



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