Important Reminder: Complete, Review, and Update Beneficiary Designations

Current federal estate tax exemption and effect on beneficiary designations

The current federal estate tax exemption is a very generous $13.61 million for 2024. As a result of this all-time high exemption amount, many individuals and families may totally avoid federal estate tax - and therefore may believe that there is nothing to do with respect to the transfer of an individual’s assets. However, there may be a trap for the unwary with respect to named beneficiaries, who may receive assets directly without being governed by the individual’s will or estate planning.

This article addresses the issue of named beneficiaries and is a reminder for all individuals to check their beneficiary designations for bank accounts, brokerage firm accounts, tax-favored retirement accounts, company benefit plans, life insurance policies, annuities, and 529 college savings accounts.

If you haven't yet completed your beneficiary designation forms, you should do it now. If your beneficiary designation forms are out of date because of any number of major life events – such as marriage, divorce, birth of a child or grandchild, or death of a previously named beneficiary, you should change them right now.

Failing to complete and update beneficiary designations can have dire consequences

If these simple tasks are delayed until it is too late, the consequences can be dire. Here are a couple of cautionary real-life horror stories to consider and possibly encourage action.

Real-life horror story No. 1

How would you feel if you died unexpectedly, and your none-too-beloved ex-spouse, who you intended to get nothing further after your recent divorce, was allowed to vacuum up your company pension benefits and the proceeds from your company-provided life insurance coverage?

Well, if you're deceased, we really don't know if you would feel anything. But if you could, you would probably be very unhappy if you wanted your offspring from an earlier marriage to inherit the money.

Unfortunately, in one real-life case, Dad failed to change the beneficiary designations for his pension benefits and company life insurance coverage after his divorce. His ex-spouse was still the named beneficiary for these benefits. Dad then died in a car crash. The U.S. Supreme Court ruled 7-2 that the beneficiary designations trumped a state law that would have automatically disinherited the ex-spouse due to the divorce. So, Dad's ex-spouse got the money, and his kids paid for an unsuccessful legal fight that went all the way to the Supreme Court.

Real-life horror story No. 2

In another real-life case, Dad's ex-spouse collected $400,000 from a company savings and investment plan even though the ex-spouse had specifically waived any interest in the plan pursuant to the divorce agreement. Believing the divorce agreement was the last word on the subject, Dad failed to turn in the form to officially change the plan beneficiary from his ex-spouse to his daughter. He died seven years after the divorce. The company plan document stipulated that beneficiaries could only be changed by submitting the required form, which never happened. The U.S. Supreme Court unanimously ruled that the outdated beneficiary designation trumped the divorce agreement. So, the ex-spouse got the $400,000, and the daughter got nothing.

Key point: These Supreme Court decisions weren't even close calls, so we're not trying to exaggerate the issue here.

Our advice

Divorce isn't the only situation when failing to turn in or update beneficiary designation forms can cause big problems for the transfer of your assets to heirs. It's just perhaps the most obvious situation. The same basic issue exists if you become disenchanted with an adult child who has just decided to dedicate the rest of his life to getting more tattoos. Or you might now want to leave more life insurance benefits to an adult child who just had twins and a bit less to childless offspring. Or, unfortunately, a previously named beneficiary has passed away. When things change, beneficiary designations may need to change too.

Another advantage of designating beneficiaries is it avoids probate. The applicable assets go directly to the beneficiaries by operation of law. In contrast, if your estate is named as the beneficiary, with you depending on your will or living trust document to direct the money to the intended parties, the estate must go through the potentially time-consuming and expensive process of court-supervised probate before the assets are allowed to arrive at the intended destinations.

You should also consider naming contingent beneficiaries. These are beneficiaries who stand in line behind the primary beneficiaries. Contingent beneficiaries receive the applicable asset if the primary beneficiaries die before the client does. The most common contingent beneficiaries are grandchildren.

Warning: You shouldn't rely on a will or living trust document to override outdated beneficiary designations. Generally, whoever is named on the most recent beneficiary form (which may not be nearly recent enough) will get the asset automatically if you die, regardless of what other documents might say.

Special considerations for married individuals

For married people with accounts that have the spouses named as joint owners with right of survivorship, the surviving spouse will automatically take over sole ownership when the first spouse dies. In this case, each spouse may want to name some contingent beneficiaries to cover the possibility that the spouse predeceases the other spouse. Note that in the nine community property states (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin), the spouse's consent may be required to make beneficiary changes because assets accumulated during marriage are generally considered to be owned 50/50.

How to update beneficiary designation forms

For bank and brokerage firm accounts, fill out and submit a Transfer on Death (TOD) or Payable on Death (POD) form to name or change beneficiaries. For tax-favored retirement accounts, employer-sponsored benefit plans, life insurance policies, and annuities, fill out and submit beneficiary designation forms to name or change beneficiaries. Finally, for 529 college savings accounts, fill out and submit a beneficiary change form to change the account beneficiary.

Conclusion

Checking beneficiary designations at least once a year or whenever significant life events occur is recommended. It usually only takes a few minutes to conduct a checkup and make any needed changes. The necessary forms can often be accessed online. But if you wait, it could turn out to be too late, as illustrated by the horror stories presented earlier.

Please contact your Herbein tax consultant if you have questions regarding this article or need assistance with the beneficiary designation process.

Article contributed by Barry D. Groebel