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Myth 18: “Instead of estate planning, I’ll just take care of everything through account beneficiary designations.”

Reality: Beneficiary designations might work for some of your assets, but they won’t work for others.

With certain assets such as life insurance, retirement accounts, other investment accounts, and some bank accounts, you have the option of designating beneficiaries to whom the proceeds in those accounts will be paid upon your death. It’s a very good idea to utilize such beneficiary designations, but there are also several cautionary items to note with respect to such designations.

First, you must ensure that you comply strictly with the requirements of the financial institutions when you make beneficiary designations. If you don’t fill out the correct form or if you fill it out wrong, the institution could later reject your beneficiary designation. “Man’s mistake cost his children $400,000 of an IRA inheritance” was the title of a sad article published on Yahoo Finance on June 27, 2014. The article discussed the tragic consequences that followed when a beneficiary designation form had not been properly completed and accepted by a man’s IRA custodian.[1] The result was that $400,000 the man had intended to go to his sons and daughters ended up with the man’s wife (who was not their mother). So again, point number one with beneficiary designations is to ensure that you get the correct form, properly complete it, and verify that the form was accepted by the financial institution—and get that acknowledgement in writing.

The second consideration with regard to beneficiary designations is that if you designate your sons and daughters as the beneficiaries of your accounts, upon your passing, they will just get a large check in the mail. Think for a moment; would this really be what you intend? Will they be prepared to handle checks for $100,000 or more? Will they be responsible enough to safeguard and protect large amounts of money? Perhaps, but this is often not the case and thus not what the parent desires or intends. This is particularly true when the amounts to be received by such children (or any other beneficiaries for that matter) are actually several hundred thousand dollars—all at once! What’s the alternative? Good question. Glad you asked.

One alternative to just giving a very large, one-time distribution is to designate your trust as the beneficiary. In that situation, you set up various parameters and controls in your trust that specify how much is to be paid out over time rather than all at once and other details. Among the benefits of this type of setup is the asset protection element that follows.

On the topic of asset protection (no small consideration these days), you should understand that if you simply specify how much money is to be paid outright to your sons or daughters, for example, through your beneficiary designation, there is no asset protection. Therefore, in the event they receive a big payout from your account and then get divorced or sued, the full amount of the distribution will be subject to divorce and/or creditor claims. On the other hand and in stark contrast, if you instead designated your trust rather than your son or daughter as the beneficiary of your account and the trust has a preset program (which you designed) of paying the money out to the beneficiary (your son or daughter) over time in increments, this could offer substantial asset protection.

Let’s say your trust provides that your assets will be paid out over the course of five years, 20 percent a year, to your son or daughter. Then, after year one of this arrangement, after 20 percent of the trust assets have been paid, your son or daughter gets in a car accident and is sued for $2 million. In this situation, only the 20 percent that was distributed would be subject to creditor claims; the other 80 percent is protected from this lawsuit, from a potential divorce, and from all other creditor claims (as long as it stays in your trust).

This asset protection feature is the major reason why some parents and grandparents decide to keep assets in their trusts for longer periods of time while providing for periodic and rationed payments.[2]

[1] In 2008, just prior to dying from cancer, Mr. Smith undertook several efforts to get his affairs in order, including getting a will in place. Unfortunately, a single, simple, but awful mistake undercut and destroyed all his plans relating to his sizable retirement account. Several months following Mr. Smith’s death, his children realized that his IRA beneficiary form had been filled out incorrectly. Instead of specifically listing the names of his children, Mr. Smith had written that his account should be allocated and paid out “pursuant to my last will and testament.” This was subsequently rejected by the IRA custodian, who then, by default, paid all the account proceeds to Mr. Smith’s wife (of two months).

[2] The recent U.S. Supreme Court opinion in the Clark v. Rameker case, holding that inherited IRA accounts are not protected in bankruptcy, is yet another reason to utilize a “qualified beneficiary” trust as the named beneficiary of your retirement accounts rather than naming beneficiaries outright. Please contact us to receive our free report on this case and its application.