Beneficiary Designations – Proceed with Caution

Whenever we purchase a life insurance policy, open a mutual fund, or enroll in a company retirement plan, we are usually asked to designate a beneficiary. After naming these individuals, we never give it much thought again. Maybe you’ve named your spouse, one of your parents or your children. After your death, these assets are designed to be paid directly to the person named as the beneficiary, avoiding probate in the process.

Sounds straightforward, right? Sometimes, it’s not that easy. Here are some examples of problems that may arise with named beneficiaries:

• If the beneficiary you named is incapacitated when you die, the funds will likely not go directly to that person. Most life insurance companies will not pay a benefit directly to an incompetent person. They will likely insist the Probate and Family Court get involved and take control of the funds through a costly appointment of a guardian.

• If you pass away and a minor is named as the beneficiary, the Probate and Family Court will likely again get involved. Financial institutions will not pay these funds directly to a minor, nor will they pay it to another person, such as a parent, to hold for the child. They do not want the potential liability and will usually require proof of a court-supervised guardianship.

• If the beneficiary you name dies before or at the same time as you and you have not named a secondary beneficiary, the proceeds will have to go through probate so they can be distributed with the rest of your assets.

• As a young person, you may have purchased a life insurance policy and named your parents. If later on you marry and do not change the beneficiary to your spouse, he or she will not benefit from the policy upon your death.

• Sometimes account owners avoid naming a person and try to solve the problem by naming “my estate” as the beneficiary. This may create a whole different set of unexpected consequences, mainly the funds will have to go through the time consuming and expensive court supervised process of probate. The funds will be counted in the owner’s estate and may be subject to estate taxes.

Even if the life insurance policy or financial assets is paid to the named beneficiary, new problems may rise depending how the proceeds are actually paid. Some examples:

• Parents may have children or beneficiaries who cannot adequately manage their own finances or recklessly spend large sums of money. They may have creditors filing claims against them for unpaid credit card balance or loans. A large financial windfall could be spent in ways the owner never intended or would approve, or taken away before they receive them for their financial liabilities.

• If the beneficiary receives a tax-deferred annuity he/she may decide to “cash out” and negate your careful planning for continued long-term tax-deferred growth.

• Naming someone as a beneficiary with the promise the funds they receive will be used for the care of disabled or elderly family member. Sadly, sometimes the money may just be too tempting and these promises may not be honored.

• If your child or spouse is receiving government benefits, such as social security disability payments or Medicaid, naming this person as a beneficiary could jeopardize their continued receipt of government benefits.

Creating a Trust and naming it as the beneficiary of the life insurance policy or financial asset can solve many of the problems described above. To read more about Trusts and how they can be a useful estate planning tool, see our blogs Trusts: Not just for the Rich and Famous and What are the Different Types of Trusts? .

More importantly, reviewing your beneficiary designations with an experienced estate planning attorney will help ensure your funds go where you intended and for its intended use.