Beneficiary Designations for assets such as life insurance policies, retirement accounts, etc. allow you to specifically assign who will inherit those assets when you die. On one hand, Beneficiary Designations are the simplest form of Estate Planning – but at the same time they are one of the biggest reasons why Estate Plans fail. Here is what you need to know about Beneficiary Designations and why they are so important to your Estate Plan:
1. How Do Beneficiary Designations Fit within Your Estate Plan?
One of the biggest misconceptions about Estate Planning is that if you have a Will or Trust – those documents automatically cover all assets that you own. THAT IS NOT TRUE. Whenever I work with a client on their Estate Plan – the first thing we talk about is how we need to classify their assets for Estate Planning purposes. In general you have three types of Assets for Estate Planning: 1: Probate Assets; 2. Jointly Held Assets; and 3. Beneficiary Assets. See the Estate Asset Diagram below.
Here is an explanation of the three different Estate Planning Asset Classifications:
Probate Asset Classification: These are Assets that are owned by one person only and DO NOT have beneficiary designations. Examples of Probate Assets are a car, a bank account (without a POD designation) or real estate that is owned just in your name. These assets are called Probate Assets because when you die – they do not automatically transfer to someone else – we have to look at your Will to see who inherits that asset. In Illinois – and most other states – in order to legally transfer title of those assets to your heirs those assets have to go through a court process called “Probate” or those assets have to be eligible for a Small Estate Affidavit. Most people want their estate assets to avoid Probate when they die.
Joint Asset Classification: Joint Assets are assets that are owned jointly by two or more people. An example is if a husband and wife own a bank account or a house jointly. If they own the account as “Joint Owners with the right of survivorship” then when the first spouse dies – the surviving spouse becomes the 100% owner of that property automatically. Joint assets avoid Probate because the assets automatically transfer to the surviving owner via Illinois law.
Beneficiary Asset Classification: These are assets that have Beneficiary Designations available to them. These assets are listed in the Beneficiary Assets Category in the Estate Asset Diagram above. With these assets you can designate a beneficiary who will automatically inherit that asset when you die. Assets with Beneficiary Designations avoid Probate.
With that background information we can now discuss why Beneficiary Designations are so important to your Estate Plan and why Beneficiary Designations often lead to Estate Plans failing. Here are some of the most important things you need to know about Beneficiary Designations:
2. Your Will or Trust Documents do not Cover Your Beneficiary Assets.
This is the most common misconception people have about estate planning. Just because you have a Will or Trust – does not mean that all of your assets will be covered by those documents. Beneficiary Designations override your Will and Trust documents when it comes to Estate Planning. Your Will only covers assets that are considered “Probate Assets” — all other assets in your estate will automatically transfer to your designated beneficiaries or to the joint owners of your property. If you have a Trust you have to actually transfer your assets into the Trust directly when the Trust is created OR make your Trust the beneficiary of assets that have beneficiary designations.
3. Beneficiary Assets Can be the Majority of Your Estate Assets.
The Estate Asset Diagram above has a list of all of the different types of assets that have Beneficiary Designations. The bulk of your estate assets probably consists of 1 – retirement accounts; 2 — life insurance; and 3 — equity in your home. Retirement accounts and life insurance have Beneficiary Designations directly associated with them. In Illinois you can name beneficiary designations for your Home through a document called a “Transfer on Death Instrument” or “TODI” for short. A TODI is a deed-like document that is recorded where you name beneficiaries for your home. Here is an article I wrote with more information about TODI’s. You may have a very detailed Will or Trust for your Estate Plan – but as you can see — those documents may only be covering a small portion of the assets of your estate – because Beneficiary Assets are not automatically subject to your Will or Trust.
4. Many Times Beneficiary Designations are Wrong and Need to be Updated.
I recommend that you review your Beneficiary Designations at least every two years and upon the happening of any major life event such as marriage; divorce; birth of a child; death of a loved one; etc. It is easy to forget about your beneficiary designations. I can tell many horror stories of ex-spouses inheriting retirement accounts and receiving life insurance proceeds. Maybe you took out a life insurance policy 20 years ago before you had children and you never designated them as a beneficiary or secondary beneficiary of your policy. I have seen blank Beneficiary Designations – which means that those assets will have to go through Probate before it is received by your heirs. It is very important to review your Beneficiary Designations regularly.
5. A Proper Estate Plan Includes a Comprehensive Estate Asset Analysis with Beneficiary Designation Review.
Your Estate Plan will fail if you don’t review and account for your Beneficiary Assets. Proper Estate Planning is more than just drafting a Will or Trust. It involves a comprehensive review of your Estate Assets and classifying them in the “Probate”; “Joint” or “Beneficiary” asset categories. Once that is done we can determine whether a Will or Trust plan is best for you. We can also determine what assets will be transferred through Beneficiary Designations and what assets will be transferred through a Will or a Trust. Finally, if you have a Trust–Based Plan, we will either re-title Beneficiary Assets directly into the Trust or rename the Trust as the Beneficiary of those assets. A proper Estate Plan takes a comprehensive approach that acknowledges and accounts for your Beneficiary Assets – it doesn’t neglect them.
6. Updating Beneficiary Designations Can be Easy or Hard.
Sometimes updating Beneficiary Designations is very easy – log into your account online, click a few boxes, done. Other times updating Beneficiary Designations can be a more difficult process – the company may require paper forms to be signed, witnessed, notarized – and/or require the dreaded “Medallion Signature Guarantee” (a super notary that only certain banks have). If you have a Trust of any type, naming your Trust as a beneficiary– whether it is a Revocable Living Trust; Testamentary Trust; Children’s Trust; etc. may require extra steps with the life insurance company or custodian. Each company is going to have their own rules, procedures and processes on how to change your Beneficiary Designations. Naming Beneficiaries for Retirement Assets can be more complex. Here is an article about Retirement Assets that I wrote. We at the Ritchie Law Office, Ltd. regularly assist our clients with changing Beneficiary Designations.
As you can see – Beneficiary Designations are a fundamental part of Proper Estate Planning. Neglected Beneficiary Designations cause many Estate Plans to fail. Have you reviewed your Beneficiary Designations lately? Consider contacting the Ritchie Law Office, Ltd. for a Comprehensive Family Wealth Strategy Session to review your out of date Beneficiary Designations and to make sure your Estate Plan doesn’t fail.