Take this Important Estate Planning Step Now

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June 29, 2017

With the federal estate tax exemption at a generous $5.49 million for 2017 (up from $5.45 in 2016) the topic of estate planning may have fallen completely off your radar. After all, you may think there’s no way your estate would lose money if you happen to die between now and the end of 2017, so there’s no need to do anything.

Wrong! There is an important estate planning action you should take right now. Check the beneficiary designations for your bank accounts, brokerage firm accounts, tax-favored retirement accounts, company benefit plans, life insurance policies, annuities, and 529 college accounts.

If you have not yet turned in the forms to officially designate beneficiaries because you just haven’t gotten around to it, please turn them in. If your forms are out of date, turn in new ones.

Many people fail to take these simple steps, and the consequences can be dire. If you need a couple of real-life horror stories to prove the point, check out the right-hand box.

Let’s say you die and your ex-spouse, who you intended to get nothing further after your divorce, was allowed to collect your company pension benefits and the proceeds from your company-provided life insurance. You intended for your children from an earlier marriage to get the money but you never got around to changing the beneficiary designations made years ago. Without the updated beneficiaries being listed, the money would go to your ex-spouse.

Of course, divorce is not the only situation when failing to turn in or update beneficiary designation forms can cause big problems for an individual’s intended heirs. You could have the same issue if you become disenchanted with, or estranged from, one of your adult children. Or you might want to leave more of your life insurance benefits to an adult child who just had twins and a less to your childless offspring. You get the idea. When things change, your beneficiary designations may need to change too.

Here is an action plan.

Institution

Fill Out and Submit

For bank and brokerage firm accounts: A transfer on death (TOD) or payable on death (POD) form to name or change your beneficiary or beneficiaries.
For tax-favored retirement accounts, employer-sponsored benefit plans, life insurance policies, and annuities: Beneficiary designation forms to name or change beneficiaries.
For 529 college accounts: A beneficiary change form to change the account beneficiary.

Beyond making sure your money goes where you want, another advantage of designating individual beneficiaries is that it avoids probate. The benefits go directly to the named beneficiaries.

In contrast, if you name your estate as your beneficiary and depend on your will to direct the money to your loved ones, the estate must go through the potentially time-consuming and expensive process of court-supervised probate before the money is allowed to arrive at the intended destinations.

For Married Couples

If you are married and have accounts set up with you and your spouse as joint owners with right of survivorship, the surviving spouse will automatically take over sole ownership when the first spouse dies. If that is what you intend, you may not have to do anything. Still, you may want to name some secondary beneficiaries to cover the possibility that your spouse dies before you do.

Note that in the nine community property states (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin), you will usually need your spouse’s consent to make beneficiary changes because assets accumulated during your marriage are generally considered to be owned 50/50.

Your Will Has No Impact

Do not depend on your will to override outdated beneficiary designations. As a general rule, whoever is named on the most-recent beneficiary form (which may not be recent) will get the money automatically if you die — regardless of what your will might say.

Do You Have Money in IRAs?

If you have a hefty balance in one or more IRAs, consider dividing up the existing account(s) into separate IRAs for each of your intended beneficiaries. That way, they can act independently when they inherit the money, and they can each calculate required minimum distributions from the inherited balance based on their individual life expectancies.

You can split up an IRA by making tax-free rollovers into new accounts set up for each beneficiary. IRAs with multiple beneficiaries are more problematic, because all your beneficiaries are unlikely to have the same objectives for the inherited money.

Two Supreme Horror Stories

1. Beneficiary designation more important than state law after untimely death. David Egelhoff, a Washington state resident, failed to change the beneficiary designations for his pension benefits and life insurance after his divorce, so his ex-wife remained the named beneficiary.

Two months after the divorce, Egelhoff was killed in an auto accident. He had no will. The life insurance proceeds of $46,000 were paid to the ex-wife. Egelhoff’s children from a previous marriage, who were his statutory heirs under state law, sued to recover the life insurance money. In a separate action, they sued to recover the pension plan benefits.

Their argument: Washington state law would have automatically disinherited the ex-spouse. In Washington, interest in non-probate assets such as life insurance policies and employee benefit plans, is revoked if a marriage is dissolved or invalidated.

At issue was whether state law pre-empted the federal Employee Retirement Income Security Act (ERISA), which governs benefit plans. The problem: ERISA states that it supersedes “any and all state laws.”

The U.S. Supreme Court ruled that Egelhoff’s pension and life insurance beneficiary designations trumped Washington state law. The state law “directly conflicts with ERISA’s requirements that plans be administered, and benefits be paid, in accordance with plan documents.”

So the ex-wife got the money, and the children only got the bills for a lengthy, unsuccessful legal fight that went to the Supreme Court. (Egelhoff v. Egelhoff, 532 US 141, Supreme Court, 2001)

2. Beneficiary designation rules even when divorce agreement states otherwise. William Kennedy was a participant in his company’s savings and investment plan. He named his wife the designated beneficiary of the plan, and named no contingent beneficiary. The couple divorced 20 years later.

After Kennedy died, his ex-wife collected $400,000 from his company savings and investment plan even though she had specifically waived any interest in the plan under the divorce agreement. Kennedy’s estate, with his daughter as the executrix, sued the company and the plan administrator claiming that his divorce decree amounted to a waiver of the benefits on the ex-wife’s part. This case also went all the way to the Supreme Court.

The estate argued that Kennedy believed the divorce agreement was the last word on the subject, so he didn’t turn in a form to change the beneficiary from his ex-wife to his daughter. The company plan document stipulated that beneficiaries could only be changed by submitting the form.

The Supreme Court ruled that the outdated beneficiary designation trumped the divorce agreement. “The plan provided an easy way for William to change the designation, but for whatever reason he did not,” the High Court noted, so the plan administrator properly distributed the benefits. (Kennedy Estate v. Plan Administrator for the DuPont Saving and Investment Plan, Supreme Court, 2008)

Note: An IRA can be split up tax-free after your death, but that requires somebody to do some tax-smart thinking, and you may not be able to count on that after you’re gone.

Conclusion

In many cases, keeping your beneficiary designations up to date can obviate the need for a will. The key words are up to date. It is a good idea to check your designations at least once a year or whenever significant life events occur. It usually only takes a few minutes to conduct a checkup and make any needed changes, and you can often get the forms online. But if you wait, it could be too late.


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