Beneficiary Designations

What is a Beneficiary Designation and Why It’s Important

A designated beneficiary is the named inheritor of an estate, trust or will created by a decedent for the purpose of asset distribution.

Estate assets distributed to beneficiaries typically involve bank accounts, investment portfolios, pension funds and retirement accounts, as well as real property such as real estate, art, fine jewelry, yachts, and other items of worth. Federal and state rules providing guidelines to designation of beneficiaries in estate law matters, clearly define proportional entitlements and tax-exemption for surviving spouses and children. Issues of creditor attachment and probate are key topics when planning beneficiary designation and distribution of asset directives for an estate or trust.

Why Designating Beneficiaries Matters

Beneficiary designation is a named person of an estate or will. Beneficiary designations are named within life insurance policies, investment retirement accounts (IRAs), 401(k)s, and other pension fund accounts assigning death benefits. Transfer of assets at the end of an account owner’s life will include Pay-on-death (POD) or Transfer-on-death (TOD) directives involving named beneficiaries. Estate directives also contain instructions for beneficiary designations and asset distribution with specified terms and conditions.

Beneficiary designation is a standard within life insurance annuities and related insurance policies assigning the distribution of benefits to an insured’s family members. Account owners and policy holders also have the option of designating proceeds to friends or charity in a written and notarized Will. Entities not considered “human” by law, are not entitled to estate distribution as designated beneficiaries, even if named in account documentation.

Estate planners and CPAs alike concur there are risks in relying on beneficiary designations for execution of an estate and its will. For instance, if a designated beneficiary predeceases the estate owner, the intent of its originator may be legally “frustrated” at time of death. In other words, there is a “bureaucratic” problem with the administrative distribution of an estate owner’s finance and other assets if beneficiary designation has been left to the individual institutions and their account agreements. With no binding estate trust account, or even a Will, the enrichment of beneficiaries can be lost without designation as part of a coherent estate plan. The risks associated with reliance on beneficiary designation within individual accounts can be reduced by way of trust formation and estate planning techniques offered by licensed attorneys, CPAs, and financial planners.

How a Trust Protects Designated Beneficiaries

Estate planners acknowledge a trust account protects designated beneficiaries better than a will in cases where an originating owner’s incapacity to act requires trustee secession. In such case, durable power of attorney to a named trustee successor on record, transfers financial control to an executor of the estate. The trust also affords individual, designated beneficiaries better protection, as those names persist as part of trust account documented record. To obtain proceeds, designated beneficiaries are required to file a claim with a copy of the decedent’s death certificate to obtain trust assets and other benefits. The custodian of each account is also responsible for verification of a beneficiary’s relationship with the decedent, and the account record before distributing account funds to that party.

Beneficiary Rights and Protections

Beneficiary designation eliminates the likelihood an estate will be subject to lengthy probate proceeding. Professional estate planners recommend setting up a trust as part of estate for this reason. Will execution involves named beneficiary designation for purpose of asset distribution from a trust. The continuity of named beneficiary designation on record affirms an estate has been planned properly. The presence of designated beneficiaries in both the Will and trust directives, documents an estate owner’s intent at the end of life.

In this manner, the act of designation protects the estate from fraud. Estate rules of designation overrule mistake that external parties are enriched or accorded the same rights, protections, or enrichment of an estate’s beneficiaries after its owner or spouse is gone. In circumstances where no designation exists, or a will is contested, rules of intestate secession preempt such claims. It is important to note, creditor attachment of an estate may result in probate in states where it is allowed.

When Estate Rules of Intestacy Apply

The estate’s executor and account custodians distribute assets to designated beneficiaries according to state rules of estate at the time of an account owner’s death If no beneficiary is designated, or the person has died prior to the decedent, default distribution to the party listed within the account documentation applies. Probate courts have the power to summons accounts for review. Probate proceedings determine if rightful heirs exist if a will is contested, or not availed at time of death. In circumstances where it is determined there are no lawful heirs, the financial accounts of an estate escheat to state treasury coffers.

The Law of Intestacy applied by U.S. courts is an estate law rule that permits designation of beneficiaries and distribution of assets when there is no will. Beneficiary designation is accorded proportional distribution of estate assets within rules of intestate secession. A sequential transfer of assets to surviving spouses and children, followed by other surviving relatives takes place. Adopted children and those born out-of-wedlock are given consideration as “natural born” children, whereas foster children and stepchildren not legally adopted, are not. Finally, grandchildren are automatically designated as beneficiaries if a parent is deceased at the time a grandparent dies.

Designated Beneficiaries, Distribution, and Taxation

The U.S. federal Internal Revenue Service (IRS) tax rules for surviving spouses of estate holders provides a tax-exempt marital deduction for purposes of annual income tax reporting of income derived from estate and trust accounts. Beneficiaries who are not spouses are not universally covered by IRS estate law rules of tax-exemption. Some assets such as life insurance policies restrict tax-deferral with 10-year rule limits on beneficiary claims. Some retirement IRAs permit distributions to be passed from an account to a surviving spouse, and on to beneficiaries without tax implications depending on the product. The standard 10-year rule limit on beneficiary claims does not apply to child beneficiary distributions received after an account owner(s) passes.