Beneficiary Designations Supersede Wills and Trusts

When you designate the beneficiary in a retirement account or life insurance policy, one little mistake can make all of your best-laid plans go awry.

When it comes time for the insurance company to pay death benefits, it doesn't matter what your will says, what your spouse says, or what your trustee says. It doesn't matter because the beneficiary designation on a life insurance policy, IRA or 401(k) account trumps them all. This important reminder is provided courtesy of the New York University Law Review in its recent report, "Accidental Inheritance: Retirement Accounts and the Hidden Law of Succession."

Follow the Money

Americans hold more than $9 trillion in employee-sponsored defined-benefit plans and IRAs, the report says. For most people, their retirement accounts are their biggest non-probate assets. But unlike other non-probate assets, such as life insurance policies and revocable trusts, when you set up your 401(k) or other retirement account, you did it with yourself in mind, not beneficiaries who outlive you. You may have set it up the first time you took a job with an employer who offered that benefit, and in doing so you might have designated a beneficiary that, today, would not be your first choice.

As the years, jobs and account rollovers passed, you might have paid no attention to your beneficiary designation, perhaps assuming that, to the extent you thought about it at all, your long-ago designation would be superseded by your will or trust or, in some cases, a prenuptial agreement or divorce decree.

If that’s what you thought, you would be wrong. Even if your will or other estate planning documents are more accurate and up to date, the beneficiary designation that you entered as part of your plan enrollment form takes precedence. The result can be a form of accidental inheritance: Your retirement account – possibly your most valuable asset – could be doled out in ways you no longer intend, to a person you no longer wish to enrich.

States' Rights

Some states, by statue or case law, hold that only the beneficiary named in the beneficiary designation form is entitled to these assets, regardless of whether your will, trust or other document specifically identifies the account and names someone else as its beneficiary. Other states have vague standards that can result in costly litigation between the beneficiary named in the beneficiary designation form and the beneficiary named in your will or trust.

Employer-sponsored plans, such as 401(k) accounts, are protected by the Employee Retirement Income Security Act. ERISA prohibits account holders from changing the beneficiary designation in any way other than by using a change of beneficiary form. In theory, this makes it easier for the designated beneficiary to more quickly receive the assets. In actuality, however, it makes it easy for the assets to pass in accordance to a preference executed decades earlier, a preference long out of date because of changed life circumstances you couldn't anticipate.

The inadequacy of the current system, warns the aforementioned NYU Law Review report, is a disaster waiting to happen. The issue of beneficiary designations has already resulted in considerable litigation, but perhaps a mere drop in the bucket compared to what's to come as the Baby Boom generation continues its march to retirement.

What to Do

Review the beneficiary designations on all of your accounts before you retire to ensure that they reflect your wishes. If you see something that you don’t like, contact the plan administrator to request a change-of-beneficiary form for each account.

To be safe, you should have an experienced estate planning attorney guide you through that review, to ensure (a) the replacement of any unwanted beneficiaries and (b) total consistency between your beneficiary designation and your estate plan.

A few other tips:

• First, do not name your estate as the beneficiary, as that designation will make your retirement plan subject to probate and unintentionally accelerate the income tax due on the plan proceeds.
• Also, do not name minor children as beneficiaries. Because minors cannot, by law, control the assets until they become adults, the court would have to name a guardian.
• Finally, name one or more contingent beneficiaries. If your primary beneficiary dies before you do, the assets still can be distributed as you wishes.
  

If you may be in danger of having your wishes disregarded, we can help you make the necessary changes to get your affairs in order.

Adapted from the Daily Plan-It newsletter