Beneficiary Designations: Some Pitfalls

You might think leaving your property to your heirs would be simple enough. You make a will or a trust, you do a transfer-on-death deed for your real estate, you put your kids on your bank account, you designate beneficiaries for your life insurance and retirement accounts, and you are done. If only things were that simple. The desired result can be seriously foiled if all the above elements are not carefully coordinated.

After considering the following, we hope you agree that it is best to consult an experienced estate planning attorney. That is the person you need to help you construct an estate plan that will do what you want it to do.

A pitfall: Conflict between deeds and wills or trusts

If your will or trust conflicts with a deed for real property, the law will resolve the conflict for you by following the deed, not the will or trust. This can produce unintended results.

Suppose Mary wanted to divide her property equally between her two children, John and Jane. She recorded a beneficiary deed for John so he could inherit the house. She wrote a will leaving money to her daughter Jane that was roughly the same value as the house.

Subsequently, however, Mary forgot about John’s deed. She made another will that split everything equally between John and Jane.

On Mary’s death, John ended up getting significantly more than Jane. The portion of the second will, including the house, would be invalidated because the earlier deed would supplant the will. So John got the house through the deed, plus half the money through the will. Jane got half the money only. So naturally, Jane sued John, but she lost. That was not what Mary intended, and the unfairness damaged John’s and Jane’s relationship.

A similar pitfall: Conflict between beneficiary designations and wills or trusts

Financial accounts can transfer automatically to people of your choice, avoiding probate, if you designate beneficiaries utilizing “transfer on death” ("TOD") through your broker. But you must not depend on your will to change TOD designations. The beneficiary designations establish a contract between the holder of the account and you. When you pass, the holder is legally obligated to transfer your account to the beneficiaries you designate, regardless of what your will says. The designations, like deeds, supplant wills.

So if you have named your spouse as a beneficiary of, say, a retirement account, and then you get divorced and forget to change the beneficiary designation, your ex-spouse – and neither your new spouse nor your children nor anybody else – will receive the account proceeds when you die, regardless what your will says.

Underage beneficiaries and guardianship proceedings

Suppose your financial advisor calls to alert you that you have not designated beneficiaries on your accounts and that if you do not, your estate will have to go through probate when you pass. By making TOD designations, your beneficiary would simply present a death certificate, and the assets would transfer to him or her without the need to go to court. That sounds good. So you follow your advisor’s suggestion and designate your beneficiaries.

In the meantime, your lawyer drafts a "good" will for you. This will, as good wills should, contains a subtrust providing for underage beneficiaries. Your lawyer, echoing your financial advisor, explains that the subtrust is intended to avoid the necessity of court proceedings.

Your efforts to avoid court will be defeated, however, if you choose an underage beneficiary to receive your financial account through TOD. Guardianship proceedings would still be necessary to administer the money until the beneficiary came of age. Moreover, the beneficiary will receive the funds as soon as they come of age (18 years old in the District of Columbia and Maryland)--the "perfect age" to receive a large portion of money without strings.

It would have been better to route the gift to the underage beneficiary through a will or trust and not through the TOD designation. If wills or trusts are properly drafted, they contain provisions to administer the underage beneficiary’s inheritance privately and thereby avoid the court guardianship proceedings.

Another pitfall: Disabled beneficiaries and government benefits

The pitfall here is similar to the one above. If your beneficiary is disabled and gets a TOD (or any other kind of) inheritance, the inherited money could jeopardize the beneficiary’s entitlement to government benefits. Most benefits programs are “means-tested.” To be eligible, recipients must own practically nothing. If your beneficiary were suddenly to inherit, he or she would lose benefits and have to pay for care until the inheritance was spent. That could involve a lot of money!

Rather, similar to underage beneficiaries, the disabled beneficiary’s inheritance should be routed through a will or “supplemental needs trust” ("SNT") that imposes restrictions on spending. With those restrictions in place, the benefits would keep coming, and the inheritance assets could be used to pay for “extras” that benefits do not cover. These extras might include payment of real estate taxes, upkeep of a residence, vacations, or a flat-screen television. A trusted person would manage the inherited money, and the disabled beneficiary would still continue to receive the crucially important benefits.

Bank accounts and disabled or underage beneficiaries -The pitfall is the same as above. If you have designated underage or disabled beneficiaries by making your accounts “payable on death” ("POD"), court proceedings will be necessary for the underage beneficiary, or the inheritance could jeopardize or eliminate the disabled beneficiary’s government benefits.

“Spendthrift” beneficiaries - The problem is likewise similar here. If your beneficiary has a gambling habit or drug addiction, or if they need bankruptcy protection from creditors, and if they inherit without trust protections, the inheritance could be lost to the beneficiary’s detriment.

Joint tenancy of real property - It may be tempting to avoid probate by putting real estate in your beneficiaries’ names as joint tenants. But if multiple people own real estate jointly, all must agree on what will be done with the land, and all should contribute equally to property maintenance expenses (which usually does not occur). This often creates disputes. Two options might be to subject the property to probate, to dispose of it in orderly court proceedings, or direct that the property be sold and the proceeds distributed to the beneficiaries equally.

Joint bank accounts - The intent to avoid probate here is similar to joint land tenancy. Unfortunately, putting your bank account in your and your children’s names exposes the funds to a risk that should be avoided. Once a person is named as a co-owner of a bank account, that person has immediate and unfettered access to the funds. The funds are thus exposed to misappropriation by the joint-tenant child, or the funds can go instead to the child’s creditors in bankruptcy or to ex-spouses in divorce proceedings.

It would be better to create a power of attorney that allows a trusted agent access to bank-account funds for your benefit while you are alive. Then, when you pass, you could name beneficiaries via a POD designation with the bank – but remember the warnings above regarding underage or disabled, or spendthrift beneficiaries. Those beneficiaries’ access to funds should be protected by a trust.

A lot of moving parts

By themselves, each estate-planning strategy above could work well but taken together, they could also have an adverse impact. Crafting a plan that combines and coordinates the various strategies requires expertise and care. That care is worth taking to safeguard the assets you have built up over the years. Do not risk a result you do not want. Please call us today at 301.892.2713 or click here to schedule a complimentary Estate Planning Discovery Session to design a plan that harmonizes all the moving parts so that the gears will work together and you will leave the legacy you intended.

"Living with Your Bags Packed!"®

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This article is for educational purposes only and should not be considered legal advice.