Is It Time To Review Your Beneficiary Designations?

A will or revocable trust may form the core of your estate plan, but for most people, a substantial amount of wealth bypasses these traditional estate planning tools and is transferred to their loved ones through beneficiary designations. These "nonprobate assets" may include IRAs and certain employer-sponsored retirement accounts, life insurance policies, and some bank or brokerage accounts.

Too often, people designate a beneficiary when they acquire a nonprobate asset and then forget about it. But over time, these beneficiary designations may become inappropriate or obsolete as a result of changes in life circumstances (such as divorce, death of a beneficiary, or the birth of a child or grandchild), estate planning goals or tax laws. So, it's a good idea to review beneficiary designations periodically — or when circumstances change — and update them if necessary.

As you conduct this review, consider the following best practices and potential pitfalls:

Name a primary beneficiary and at least one contingent beneficiary. Without a contingent beneficiary for an asset, if the primary beneficiary dies before you — and you don't designate another beneficiary before you die — the asset will end up in your general estate and may not be distributed as you intended. In addition, certain assets, including retirement accounts, offer some protection against your creditors, which would be lost if they're transferred to your estate. To ensure that you control the ultimate disposition of your wealth and protect that wealth from creditors, it's important to name both primary and contingent beneficiaries and to avoid naming your estate as a beneficiary.

Update beneficiaries to reflect changing circumstances. Designating a beneficiary isn't a "set it and forget it" activity. Failure to update beneficiary designations to reflect changing circumstances creates a risk that you will inadvertently leave assets to someone you didn't intend to benefit, such as an ex-spouse.

It's also important to update your designation if the primary beneficiary dies, especially if there's no contingent beneficiary or if the contingent beneficiary is a minor. Suppose, for example, that you name your spouse as primary beneficiary of a life insurance policy and name your minor child as contingent beneficiary. If your spouse dies while your child is still a minor, it's advisable to name a new primary beneficiary to avoid the complications associated with leaving assets to a minor (such as court-appointed guardianship).

Consider the impact on government benefits. If a loved one depends on Medicaid or other government benefits (a disabled child, for example), naming that person as primary beneficiary of a retirement account or other asset may render him or her ineligible for those benefits. A better approach may be to establish a special needs trust for your loved one and name the trust as beneficiary.

Keep an eye on tax developments. Changing tax laws can easily derail your estate plan if you fail to update your plan accordingly. For instance, the SECURE Act, passed in late 2019, sounded the death knell for the "stretch" IRA. Previously, when you left an IRA to a child or other beneficiary (either outright or in a specially designed trust), distributions could be stretched out over the beneficiary's life expectancy, maximizing tax-deferred savings. Today, tax law requires most nonspousal beneficiaries of IRAs to distribute the funds within 10 years after the owner's death.

In light of this change, you should review the designated beneficiaries for your IRAs and other retirement accounts, evaluate the impact of the SECURE Act on these beneficiaries, and weigh your options. For example, you might consider naming different individual beneficiaries or leaving IRAs to a charitable remainder trust or other vehicle that mimics the benefits of a stretch IRA.

To avoid unintended consequences, review your beneficiary designations regularly to make sure they're still appropriate and that they align with your overall estate planning goals.

Beneficiary Fail Horror Stories

Two Supreme Court decisions demonstrate what could go wrong if your beneficiary designations aren’t complete and updated. In the first case, a man failed to change the beneficiary designations for his Boeing Corporation pension benefits and life insurance policy after his divorce. When he subsequently died in a car accident, the Court ruled 7-2 that the beneficiary designations trumped a state law provision that would have automatically disinherited the ex-wife. So, his ex-wife got the money, and his kids got the bills for an unsuccessful legal fight. (Egelhoff v. Egelhoff, 532 US 141, 2001.)

In the second case, a man failed to change the beneficiary for his company savings and investment plan from his ex-wife to his daughter. When he died seven years after his divorce was finalized, his ex-wife collected $400,000 — even though she had specifically waived any rights to the plan under the couple’s divorce agreement. The man mistakenly believed that the divorce agreement was the last word on the subject, but the company’s plan document stipulated that plan beneficiaries could be changed only by submitting the required form. The Supreme Court unanimously ruled that the outdated beneficiary designation trumped the divorce agreement. (Kennedy Estate v. Plan Administrator for the DuPont Saving and Investment Plan, 555 U.S. 285, 2009.)

These two Supreme Court decisions drive home a key point: Updating beneficiary designations is important. If you fail to turn in the required form, what you intended may not matter if you pass away. Outdated forms or one-size-fits-all state law may be determinative.