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You may be familiar with beneficiary designations from setting up your retirement account or talking with your financial advisor. But did you know they are one of the main tools to consider using as a part of your estate plan? Depending on your situation, a beneficiary designation may be a key part of accomplishing your estate planning goals.

But first, what is a beneficiary designation, and should you use one (or several) as part of your estate plan?

What is a beneficiary designation?

A beneficiary designation is an agreement between you and your bank or financial institution. In the agreement, you instruct the institution about who should receive your funds when you die. When you pass, the financial institution will pay the funds or assets in that account to the person you have specified.  Unlike a will or a trust, a beneficiary designation is not overseen by a court. It is a private agreement between you and your financial institution.

The following questions will help you determine if beneficiary designations should be part of your estate plan:

What is the benefit of using a beneficiary designation as part of your estate plan?

There are three key benefits to using a beneficiary designation:

  • It can be a good way to transfer tax-deferred funds. Certain tax-deferred funds, such as a 401(k) and traditional IRAs, are taxed less if they are transferred directly through a beneficiary designation, rather than through a will or a trust. The less you pay in taxes, the more money you will have to protect and provide for your loved ones.
  • It avoids probate. Because a beneficiary designation is a private agreement between you and your financial institution, it is not a part of the court’s domain. Therefore, it doesn’t go through probate at your death, and avoiding probate is one way to make life easier for your loved ones after your death.
  • It is very private. Wills become part of the public record after your death, so anyone can look up what you owned and who your beneficiaries were. While trusts are more private than wills, in many states all trust beneficiaries can read the trust agreement. Beneficiary designations are more private than both wills and trusts. In our experience the financial institution will only disclose information about the account directly to the beneficiary after you die. In some situations, this level of privacy helps avoid family conflict.

If I have beneficiary designations set up, do I still need a will?

Yes, for a few reasons.

  • Beneficiary designations only work for financial accounts. They cannot pass on real property or physical personal property.
  • Beneficiary designations do not allow for multiple levels of backups. With a will or a trust, you can have many backup beneficiaries. And we encourage this in case your main beneficiaries pass before you or do not want what you leave them.
  • Beneficiary designations are not overseen by the courts. This means that in the case of a mistake or dispute, it is the institution’s word against yours.

You should choose a customized combination of tools to achieve your goals. Beneficiary designations are great for certain assets, but it is rare for them to be the only tool you use.

[Related: Wills, Trusts, and Other Tools of Estate Planning]

If I have beneficiary designations set up, do I need a trust?

The principles of the last question apply here as well. As with a will, you may need a trust along with your beneficiary designations. But again, it depends on your situation.  A trust gives you more control over your assets and could add protection if you don’t want your financial institution to have complete control.

Also, beneficiary designations do not allow you to put conditions on the money. With a trust, you can put conditions on funds so that your beneficiaries can only receive them if certain standards are met. You can require things such as the beneficiaries must be drug-free, they must reach a certain age, or they must reach certain milestones such as finishing college, purchasing a home, or retiring. You cannot put these kinds of protective conditions in place with beneficiary designations. If you need them, a trust is a good tool for you to consider, either in place of or in tandem with beneficiary designations.

[Related: Do I Need a Trust?]

Are there tax advantages to using a trust vs. a beneficiary designation?

It depends. Trusts and beneficiary designations can each have tax advantages or disadvantages depending on your situation. Your beneficiaries, their financial situation, your financial situation, and the types of assets you are leaving behind all affect the amount you and your loved ones will owe in taxes.

[To discuss your specific situation, schedule an appointment with us. Once we know the details, we’ll be able to give you a concrete answer!]

Does a trust or will override a beneficiary designation?

No. Beneficiary designations trump any other estate planning document you have drafted.

Does a minor get money if they are a beneficiary?

If a beneficiary on your beneficiary designation account is a minor when you die in Virginia, your funds go to a guardian of the property of a minor until they turn 18. The guardian manages the funds under a court’s oversight. Practically, this means that the funds cannot be used except for emergencies, and then, only with the permission of the judge. When the child turns 18, they will receive the funds directly. However, most people dislike the thought of their child getting a large amount of money at 18, which is one of the reasons that most people choose not to solely rely on beneficiary designations to transfer their assets.

How do I change my beneficiary designation(s)?

Each financial institution has its own requirements for changing beneficiary designations. The process usually involves requesting, filling out, and submitting a Change of Beneficiary Form to your financial institution. If you have questions or need help getting started, contact your financial institution. They should be able to help you.

Beneficiary designations are not the only estate planning tool you should use. But even with their limitations, they can be very helpful in certain situations, and you may want to include them as part of your plan.

 

Have more questions about what a beneficiary designation is and how it might work as part of your estate plan? Schedule an appointment with us.