In our first conversations about estate planning with our clients, we find that most of them know the importance of having a will and a trust. They also understand that their retirement plans, IRAs, and life insurance policies have beneficiary designations, which are designated individuals who, by operation of contract, receive property from these accounts. However, only a few clients understand the significance of how these two concepts interact with each other, and how to plan appropriately to avoid derailing an estate plan with beneficiary designations that do not mirror their wishes.1
In most situations and jurisdictions, beneficiary designations supersede wills when directing property after death. This means that, if the bulk of a doctor’s estate is in retirement accounts, beneficiary designations rather than a will or a trust may guide where assets pass after death. In the highly sophisticated and complex area of estate planning, this can present tremendous issues if an attorney updates an estate plan without adequate knowledge. Here are three red flag scenarios to be aware of, in which mismatches between estate plans and beneficiary designations can turn into nightmare scenarios.
Following a divorce, most doctors remember to change their will and trust to disqualify a former spouse. However, if beneficiary designations are not changed, then a former spouse can inherit life insurance, and in more limited circumstances, retirement plans.
In a recent case, a Tennessee court held that, despite a former husband being granted the insurance policy as an asset during distribution, the former wife named as the beneficiary was entitled to receive the proceeds from the policy since the former husband had ample time to change it and did not. What’s the moral of the story? Unless required by decree to maintain it, confirm that all life insurance is directed toward the proper beneficiaries following a divorce.
When the means by which an asset is passed is not considered, unintentional consequences can result from creative planning that is not considered from all directions. In one circumstance, two doctors who were previously married with children from a first marriage had estate planning documents that left all assets to their respective children. They also had IRA beneficiary designations that left their retirement plans to their surviving spouse as primary beneficiary, with their respective children as secondary beneficiaries.
What’s the problem with this? The secondary beneficiary only applies when the first beneficiary has predeceased. This means that, when the surviving spouse inherits the IRA, the assets are rolled into their respective retirement plans. The result is a game of survival chicken—the second spouse gets all of the retirement assets, passes them to his or her children, and the children of the first spouse to pass receive nothing. These doctors would have been much better off finding a mutual solution for inheritance to all children—or the use of trusts to care for the surviving spouse for the remainder of his or her life—and directing the remaining assets to the children at death.
Direct transfers of significant property
The goal of many trusts is to protect inheritances from imprudent spending by children by limiting access to the assets until the children are certain ages. However, if children are beneficiaries on retirement accounts or life insurance without a trust involved, these children take the entire sum without restrictions or limitations.
For example, we worked with a doctor who intended for his children to receive assets outright via trust when they turned 40. He had a retirement account and a life insurance policy that did not direct the assets to the trust. Rather, it left the assets to the children directly. If the doctor were to have passed at that time, approximately $1 million of assets would have gone into the trust. The approximate $2 million of retirement assets and the $2 million of life insurance would be distributed directly to the children due to the beneficiary designations. The doctor made revisions to the beneficiary designations to redirect these assets through the trust to achieve the desired effect.
Due to the wide differences from state to state, it’s important to consult an attorney before making any changes to your estate plan. However, if any of these situations apply, contact your estate planning attorney immediately.
1. Voya Retirement Insurance and Annuity Company v. Mary Beth Johnson, et al. Tenn. Ct. App. Oct. 27, 2017.
Andrew Tucker, JD, Cfp, CPa, and John K. McGill, JD, MBA, CPA, provide tax and business planning for the dental profession and publish The McGill Advisory newsletter through John K. McGill & Company Inc., a member of the McGill & Hill Group LLC. It is your one-stop resource for tax and business planning, practice transitions, legal, retirement plan administration, CPA, and investment advisory services. Visit mcgillhillgroup.com or call (877) 306-9780.