L&H Trends Ins and Outs of Beneficiary Designations

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Most people don’t pay a lot of attention to their life insurance or retirement plan’s beneficiary designations. Singles generally name a family member such as a mother or father as the primary beneficiary and then name a sibling as a contingent beneficiary. Married insureds (or retirement plan participants) typically name their spouse as the primary beneficiary and their children as contingent beneficiaries. Sounds simple, right?
Not quite. Most people fail to update their beneficiary designations as events in their personal lives change; others fail to understand that naming minor children as beneficiaries will create problems in the event of their deaths. This also applies to an employer’s group term life insurance benefits.

Turning to the basics, a big advantage of life insurance contracts and 401(k) plan accounts is that the proceeds are immediately paid to the named beneficiaries. This means that the proceeds will not be subject to probate unless the deceased’s estate is named as the beneficiary, saving time and expense. However, it can be a two-edged sword if the deceased person’s beneficiary designation was outdated. For example, if an individual named his sister the beneficiary of his 401(k) plan balance and then failed to update the beneficiary designation after he got married, the proceeds will be payable to the sister and not the spouse.

Another common problem is a divorced person wanting to name his/her minor children as the primary beneficiaries. Depending on the state of residence, minor children cannot directly receive the proceeds of a life insurance policy, annuity or retirement plan if they are named beneficiaries. To remedy this, name a guardian to receive the proceeds for the child’s benefit, or set up a trust for the child that will be named as beneficiary. Upon the insured’s death, the trustee will become the legal owner of the proceeds and since the child will be the trust’s beneficiary, they will receive the trust’s proceeds. Examples of the beneficiary designation in this case include: “Trustees of the John Smith Trust Agreement dated 01/01/00,” “Trustee of the John Smith Irrevocable Trust dated 01/01/00” or “John Smith for the benefit of Jane Smith and John Smith.”

More issues can arise if several children are named as beneficiaries and some of them have children. In the event one of the adult offspring predeceases the insured parent, the insured must decide how such grandchildren will share in the proceeds with their other living children, with the question being whether everything will be divided equally or whether the grandchildren will split what would have been their parent’s share.

The issue can be solved by understanding the methods of distributing property to family members and heirs: per stirpes (“branches of the family”) and per capita (“by heads”). For example, say there are three adult children and one of the three dies having two children of their own. Under a per stirpes distribution, the two children of the deceased parent will each receive one-half of their deceased parent’s one-third share of the proceeds. Under a per capita distribution, the two children of the deceased parent will receive one-quarter of the proceeds along with the two adult children who would also receive one-quarter shares each. The same problem regarding having minor children named as per capita beneficiaries would remain if they are minor and legal guardians had not been named and/or a trust had not been set up.

It’s important for independent agents to raise this issue with their customers during annual reviews. Remember to consult a customer’s attorney when it comes to estate planning, especially if it involves trusts documents. And, independent agents are well advised to review their own beneficiary designations.
Dave Evans is a certified financial planner and IA l-h contributing editor.

Author: alan

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