By Jeffrey Steele
Financial advisor Gregory DeJong recalls once making small talk over the kitchen table with a woman while her husband went to retrieve a life insurance policy from their file. After a surprisingly long delay, he returned, red-faced with embarrassment. He had just realized his ex-wife remained the sole beneficiary on his only life insurance policy, more than a decade after their divorce.
“You’d think removing an ex-spouse beneficiary would be a no brainer,” DeJong, CFP and financial advisor for Naperville’s Savant Capital Management, says. “But in the turmoil surrounding the typical divorce, things slip through.”
The fact that beneficiary designations operate independently of a will or trust can provide wonderful planning flexibility, DeJong reports.
More often, however, the two are not considered at the same time, and a beneficiary designation thwarts the intent of the overall estate plan. That’s because beneficiary designations on your retirement accounts, IRAs, annuities and life insurance policies override wills. The result: people you don’t intend to inherit your assets could in fact get your money if you were to die.
“There are hundreds of stories where husbands and wives get divorced, and forget to change the beneficiary designations on their life insurance or retirement plans,” says Michael Stuart, member manager of Rolling Meadows-based Stuart Legacy Alliance. “And then they die and their money goes to their ex-spouse, rather than their kids or their new spouse.”
Not only do beneficiary designations trump the will, but joint tenancy trumps the will, Stuart adds. Let’s assume you want your house to be passed on to your children after your death, and leave your house in a will or trust to them. “If you have a joint tenancy with your wife, then the will and trust mean nothing,” he says. “You can effectively disinherit someone unintentionally.”
These examples represent just the start of the complexities involving beneficiaries, attorneys and financial advisor reports. For instance, problems can arise if children who are minors are listed by, say, a grandparent, DeJong says.
“It would be difficult for them to even claim the money, because they don’t have the legal standing to file a beneficiary claim,” he says. ”A court-appointed guardian would have to act on their behalf to collect the money.”
Another issue, DeJong says, involves the following situation. You have listed your adult offspring, a son and a daughter, as your beneficiaries. Your son has his own children, while your daughter has no children.
“Now your son dies, predeceasing you,” he says. “Do you want everything at your death to go to the surviving daughter, or do you want your son’s half to continue down the family tree to his children? Often, there is a checkbox on a beneficiary form that allows you to give the money down the family tree.”
One of the most common sources of confusion is the belief among many people that assets for which they have beneficiary designations will not be included in their taxable gross estates, says Lindsey Paige Markus, partner and estate planning attorney with Chuhak & Tecson P.C.in Chicago.
There is no question that beneficiary designations allow the assets to pass outside of probate, meaning the court system. But they are still included as part of that individual’s taxable gross estate, she reports. The government allows a certain amount of money to pass tax-free, which is identified as the exemption amount, based on the year the individual dies. At the federal level, the exemption amount is $5.34 million per person. But it is $4 million at the state level. The estate tax rates for Illinois residents range from 28-1/2 to 50 percent.
“We’re talking about the potential for a hefty tax on the estate,” Markus says. “The estate will pay the tax and the balance passes to the beneficiaries. The assumption that because the asset has a beneficiary designation and will pass outside of probate it will not be taxed is an incorrect assumption. With proper planning, a lot of these taxes can be minimized or even avoided.”
Even if an individual does not have a multimillion dollar estate, that does not mean he or she does not need an estate plan, she adds.
The threshold to avoid probate in Illinois is $100,000. An estate plan can ensure assets avoid probate and provide asset protection to beneficiaries in a tax-efficient fashion, Marcus says.
If the will is trumped by beneficiary designations governing much of many people’s assets, and by joint tenancy, why even have a will prepared?
The answer is that even for those with the bulk of their assets in IRAs, annuities and insurance policies, there are likely many other assets that don’t provide the opportunity to designate a beneficiary, DeJong says. They can include a home, vehicle, bank accounts and personal possessions.
“The disbursement of brokerage accounts, if held in your name directly and not part of a retirement plan, will be under the provisions of a will,” he says. “The will is powerful, because it takes care of everything else.”
If a decedent has more than $100,000 in her individual name at the time of her death, even if there is a valid will that is not contested, the assets are subject to probate, says Markus.
“In contrast,” she adds, “if the decedent created a revocable living trust during her lifetime, assets titled in her trust at the time of her death circumvent the probate process. This enables beneficiaries to have immediate access to the funds. In addition, the trust allows the assets to pass in a tax efficient fashion and can be structured to provide asset protection for beneficiaries.”
With life insurance, Markus says it is fairly easy to simply list a revocable living trust as the beneficiary of the life insurance. “For IRAs, however, people need to be careful. If the revocable living trust does not have the necessary language for the trust to be considered a designated beneficiary, the income tax consequences can be devastating.”
With so much at stake for many people, it can be essential to seek the counsel of a good estate planning lawyer. The best way to find one is through word-of-mouth referrals, Stuart says.
“Talk to people who have gone through the process,” he urges. “Make an appointment and talk about what your goals are, what’s really at stake, and discuss the legacy you want to leave.”
Also, go into that meeting with some sense of your total assets, how much is in each account and the approximate value of your home. “A good attorney will work with the client’s financial advisor and CPAs to make sure the plan is complete,” Stuart says. “Coordinating the team of advisors is important.”
Originally appearing in the Chicago Tribune Primetime section May 9, 2014.
Reposted with express permission of the author.