An affluent client comes in for estate planning and explains that one of her foremost objectives is to make sure that the wealth she has accumulated over a lifetime of hard work is left to her children. A significant amount of her net worth happens to be held in an IRA account. After a thoughtful design meeting and discussion, a comprehensive estate plan is created for her. The plan includes a trust and a pour-over will to ensure that any assets not transferred to the client’s trust during her lifetime will end up in her trust after her death. Her trust includes numerous provisions to ensure the assets left in trust for her children are well protected. Sound like a solid plan? Yes, but…
Following the death of an account holder, an IRA account (and insurance policies, annuities and similar financial products) will pass according to what is specified on the beneficiary designation. If a beneficiary designation is never completed or is not completed properly, an otherwise excellent plan may fail. A beneficiary designation is often a fairly brief form prepared by the financial company that administers the account. But do not be mistaken – making sure beneficiary designation(s) are filled out correctly and updated is crucial!
For example, Yahoo! Finance recently reported this story. A man by the name of Leonard Smith died of cancer in 2008. Prior to his death, he worked with his attorneys and financial advisors for estate planning. He owned a $400,000 IRA account. In his Will, he provided that a certain percentage of his remaining assets would be distributed to each of his children who were referenced by name. In his beneficiary designation for the IRA he did not state the names of his children and the percentages each was to receive. Instead, he simply instructed that he wanted his IRA account “[t]o be distributed pursuant to my last will and testament.” He was undoubtedly confident that this instruction would result in his children ultimately receiving the IRA proceeds.
Unfortunately, that is not what happened. The beneficiary designation rules of that company did not permit a Will to be named as a beneficiary. What he wrote was therefore nullified and instead the default rules of the contract governed. Those default rules provided that 100% of the account was to pass to his spouse. Although Leonard Smith’s children fought in court to recover the money, the court awarded all of the $400,000 in the IRA to the father’s wife, who he married a mere two months before he died.
An incorrect beneficiary designation can act as a “chink in the armor” of an otherwise well-designed and comprehensive estate plan. Having an excellent will or trust in place that perfectly recites one’s wishes for one’s beneficiaries means little, if the proceeds of an IRA or an insurance policy never reach their intended destination.
Furthermore, it is not merely a question of making sure the designation is filled out correctly once. Rather, it is of ongoing importance to make sure the designation is updated and modified from time to time as needed. For example, assume John is married to Mary, and John fills out a beneficiary designation providing that 100% of his IRA is to pass to Mary. Later John and Mary divorce, and subsequently John marries Christine but never goes back and updates the beneficiary designation for his IRA. That means no matter how much he manifests his intent that Christine inherits his wealth upon his death, the proceeds of his IRA will be distributed to Mary, his ex-wife!
If you have an existing IRA, a 401(k), life insurance or an annuity, or if you are thinking of opening up a new account, please talk to us about the best way to complete your beneficiary designations.