Beneficiary Conundrum

Beneficiary Conundrum

Most people do not realize the power of beneficiary designation: Your beneficiary designation may result in family members becoming disinherited, or the government may restrict the amount of funds designated to an 18-year-old heir. A few examples of what to consider when naming a beneficiary are detailed in this article.

Avoid Naming Your Ex as Beneficiary
As a result of a Supreme Court ruling, beneficiary designations are binding even if you can show that the name of the beneficiary listed on the form is a mistake. In Kennedy vs. Plan Administrator, the 401(k) account holder died in 2001. He filed his beneficiary form in the 1970’s, which named his then-wife (later to be his ex-wife) as his beneficiary. In the couple’s divorce decree of 1994, each spouse waived their rights to each other’s 401(k).

Despite these facts, the Supreme Court ruled that the beneficiary form on file was binding to the ex-wife. The divorce decree was only binding for the separation of assets in a divorce and did not affect the beneficiary form on file with the plan administrator. Many divorced spouses still inadvertently list the ex-spouse as the beneficiary. As a result, it is wise to ensure that all of your beneficiary forms are updated and current, especially after a divorce.

Split Your Estate Equally Among Your Children and Their Families
You have three children as your primary beneficiaries, and one of them predeceases you. Each of your children have children (your grandchildren). In this scenario, if you pass away before updating your beneficiaries, your two children will likely split your proceeds among themselves (50-50), and the children of your deceased child will be disinherited.

The determinate for what happens in this situation is contained within the company plan document for your account or within the voluminous custodial agreement provided to you when you first opened your account. Most accounts use a pro-rate allocation based on surviving beneficiaries at the time of the account holder’s death. Most financial institutions do not want to attempt to determine whether they properly have identified a deceased beneficiary’s children. Some custodians will allow a “with rights of representation” designation if so desired to ensure that a deceased beneficiary’s children will split their parent’s share. This normally involves rules and waivers absolving the custodian from liability.

How to Designate Funds to a Minor 
Your beneficiary is a minor (under 18 years of age) and has inherited your life insurance, IRA, or 401(k); however, he or she is unable to open a bank or investment account to accept the funds because he or she is a minor—so what happens? A family member goes to court and asks the court to appoint a custodian for the minor’s assets. When the beneficiary turns 18 years old, the court then requires that the funds be disbursed to him or her.

There is a simple solution to this scenario. In most states, there is something called the Uniform Transfers to Minors Act, which allows minors to receive gifts (e.g., money) without the aid of a guardian or trustee. The Act allows you to name a custodian who can manage and invest a young beneficiary’s finances until the minor becomes of legal age (i.e., either 18 or 21 years of age, depending on the state). This allows you to select an appropriate custodian to manage your children’s money should they inherit it before legal age.

Note that custodians might rebel against the “with rights of representation” and the “uniform transfers to minors” beneficiary designations. They do not have the right to say no, so be persistent. The beneficiary designation has become the ruling form, so it is important to ensure that it truly reflects what you desire.

Still not sure what to do? Talk to an independent, fee-only advisor such as the Financial Consulate. To look for the Financial Consulate and other advisors like us go to napfa.org.