Estate planning and retirement planning are closely intertwined. As an estate planning attorney in San Diego, I have come across many mistakes and oversights made by the financial account owners. For those of you with life insurance, IRAs, 401(k)'s, and other qualified retirement and financial plans, I have enumerated the Top 5 Mistakes made on the beneficiary designation forms for those plans. These mistakes can lead to undesirable consequences that may defeat the purpose of your estate plan if not avoided.
1) NAMING THE ESTATE AS THE BENEFICIARY OF A LIFE INSURANCE POLICY: This is a mistake for myriad reasons. Of paramount concern, doing this will cause the death benefit of the policy to be subject to probate or intestate administration under the California Probate Code regardless of if you have a family trust. As I have mentioned in previous blog posts, the average probate case in San Diego can last anywhere from 12 to 18 months. This will delay access to the funds and squander the liquidity offered by the policy proceeds. Next, assuming your estate is in excess of the Federal estate tax exemption, your policy proceeds will be subject to Federal estate taxes, regardless of how ownership of the policy is structured. Last, the distribution of the proceeds is now subject to the decedent's will or California intestacy laws. This may lead to the proceeds being given to someone who the decedent did not want to receive the benefit.
2) FAILURE TO NAME A CONTINGENT BENEFICIARY: Every retirement and financial account allows for the naming of a primary, secondary, and sometimes tertiary beneficiary. Naming these beneficiaries ensures the funds are passed to whom the decedent intended, even if the primary beneficiary dies before the account owner. If a contingent beneficiary or beneficiaries are not named, the proceeds may be subject to probate and intestate administration much like in Number 1 above. Ensure your beneficiary designation form clearly identifies a primary beneficiary (usually a spouse), and contingent beneficiaries in the event the primary beneficiary dies before you.
3) NAMING A MINOR CHILD AS THE BENEFICIARY OF A LIFE INSURANCE POLICY: Too often, those with life insurance will name their spouse as the primary beneficiary, then name their minor child as a contingent beneficiary. Even if the policy owner has a trust, naming a minor as the beneficiary will create the unwanted consequence of a guardianship proceeding in probate court because the minor, under the eyes of the law, does not have the capacity to receive the funds. The guardianship proceeding is meant to name a guardian for the funds that are designated for the minor. While the owner of the policy may have thought he or she avoided probate by establishing a trust, failing to name the trust as the contingent beneficiary in lieu of his or her minor child forces the need for probate proceedings nonetheless. If you currently have a minor named as your contingent beneficiary, consider establishing a revocable trust and naming the trust as the beneficiary to avoid this unnecessary court proceeding and the associated fees.
4) FAILURE TO REMOVE AN EX-SPOUSE AS A BENEFICIARY AFTER A DIVORCE: While some marriages may be dissolved amicably, others are gauntlets of enmity and bickering. After receiving a dissolution of marriage, despite how smooth or rough the proceedings, it is common for spouses to fail to change their beneficiary designation forms to remove their ex's. If the owner of the account or policy were to die with his or her ex named as the beneficiary, no estate planning vehicle that is in place can prevent the distribution of those proceeds to the ex-spouse. Be conscious of this if you are currently involved in dissolution proceedings or are recently divorced. Update your forms!
5) NAMING IMPROPERLY DRAFTED TRUSTS AS BENEFICIARIES OF IRAs: For those of you with IRAs and other qualified retirement accounts, an attractive option is to name individuals as beneficiaries of those accounts to allow for the continued tax-deferred growth of the money over the beneficiaries' life expectancy (commonly referred to as a "Stretch IRA"). However, naming a family trust as the beneficiary of these accounts instead of an individual helps to manage and protect the funds into the future. Thus, many folks choose to name their trust as the beneficiary without consulting with an experienced estate planning attorney. Take note, if you name your trust as the beneficiary of an IRA or other qualified plan without specific and detailed language in your trust to qualify the trust as a beneficiary, you may lose the "stretch" option for those funds and your beneficiaries will lose a portion of the funds to taxes. Additionally, as a result of the recent U.S. Supreme Court ruling Clark v. Rameker, inherited IRAs are no longer exempted property in a bankruptcy proceeding. Thus, if your beneficiary inherits your IRA directly then files for bankruptcy, your IRA funds are subject to your beneficiary's creditors. Therefore, before naming your trust as a beneficiary of your IRA, consult with an experienced attorney to ensure your trust is properly drafted so you can protect the funds for your loved ones into the future.