Gary Altman
With Tax Day behind us, the IRS is now hard at work auditing as many returns as possible in an effort to make sure that citizens are playing by the rules. For this reason, the word “audit” doesn’t sound very appealing to most people.
However, in estate planning, an audit is a powerful and potentially game-changing tool. Consider the “beneficiary audit.”
Take This Into Account
One aspect of peoples’ financial lives that is often overlooked is the designation of beneficiaries to their retirement accounts, annuities and life insurance policies. As you might assume, a designated beneficiary receives an account or the proceeds of an account upon the death of the owner of said account.
But what is the correct beneficiary designation? And how do you make sure that your designations are current, correct and coordinated with your goals, objectives and estate plan? The answer is to conduct routine beneficiary audits.
A beneficiary audit involves reviewing the beneficiary designations for each of your financial accounts (e.g., retirement accounts, annuities, life insurance policies) and then analyzing how smartly those designations match up with your objectives as well as the tax and non-tax laws regarding distributions for the accounts.
Is That Your Final Answer?
It is crucial to determine if the named beneficiary is the correct beneficiary. It is surprising how often the named beneficiary is an ex-spouse, deceased family member or even someone you no longer have contact with.
People have even listed their “estate” as a beneficiary, which is disastrous in terms of payouts from retirement accounts and annuities and can result in increased court costs as well as exposure to creditors.
Any time an individual gets divorced, married, has children or has any other life-changing event, s/he should update beneficiary designations. In most states, settlement/divorce agreements or a new marriage does not supersede the beneficiary designation, even if it’s outdated. So the named beneficiary, regardless of his or her current relationship with the deceased, inherits.
One Size Doesn’t Fit All
When it comes to beneficiaries, one size does not fit all. It is important to determine if the beneficiary is a minor. In most states, a minor (i.e., a child under the age of 18) may not receive the proceeds from a life insurance policy, annuity or retirement plan directly.
Instead, if a minor is named, the minor’s parent (or someone else) must go to the local court and become the minor’s legal guardian. Not only does that cost in terms of legal and court fees, but it may be restrictive in terms of investments. Also, when the minor turns 18, all control might pass to him or her — which may or may not be a good thing.
Moreover, the court may dictate how the funds can be used prior to the age of 18, and annual accounts must be filed. Finally, some states, like the District of Columbia, are increasingly reluctant to appoint the parent as the guardian, and instead will appoint a financial institution or attorney, thereby increasing the cost.
In addition to knowing how age could impact a beneficiary designation, it’s also crucial to consider whether or not the beneficiary has special needs or other issues, such as creditors, drug habits, spending problems, etc.
For example, if a child with special needs inherits life insurance proceeds or a retirement account directly, then that child’s government benefits may be curtailed. On the other hand, if a beneficiary has a creditor or a marriage problem and inherits directly, his or her creditors, or soon to be ex-spouse, may have a claim to the inherited assets.
In cases like the examples above, where a minor or individual with special needs or other issues is the desired beneficiary, then a trust for the benefit of the minor or other individual must become the beneficiary, thereby avoiding any interaction with the court or subjecting the account to creditors, predators, ex-spouses or unnecessary spending. How these trusts are structured depend on the beneficiary and the type of account.
Don’t Forget Uncle Sam
The next component of a beneficiary audit is to determine if the retirement accounts, annuities and life insurance policies must be constructed in such a way as to facilitate the minimization of estate taxes. In Maryland, this also means that the beneficiary of life insurance policies must also be structured in a way to minimize or eliminate Maryland inheritance taxes (which are different from Maryland estate taxes).
With life insurance policies, that may mean changing both the owner and the beneficiary. For retirement accounts and annuities, it may mean changing the beneficiary. Not only is careful drafting by an experienced and knowledgeable estate planning attorney necessary, but the overall ownership and titling of the client’s assets may need to be adjusted to ensure the most tax efficient estate plan possible, from both an income and estate tax perspective.
The final component is to make sure that any estate or inheritance taxes are paid by the right party. Too many times someone will receive a retirement account or annuity as his share of a relative’s estate, but another beneficiary will be required to pay the estate taxes on the retirement account or annuity.
The tax clause of a person’s will may sometimes be the most important clause because it can radically change how assets are eventually distributed. Thus, the last aspect of a beneficiary audit is to review estate planning documents to make sure it is a coordinated estate plan, rather than one that is put together piecemeal without an overall cohesiveness.
Incorrect and outdated beneficiary designations are not fixable mistakes once you’re gone. By working with an experienced and knowledgeable estate planning attorney, you can make sure that your retirement accounts, annuities and life insurance policies are used appropriately by the right person after your death, and you can protect the assets from unnecessary income and estate taxes, court intervention, creditors, predators, ex-spouses and the like.
Gary Altman, Esq., is the principal and founder of Altman & Associates (www.altmanassociates.net), an estate planning law firm in Rockville. He can be reached at 301-468-3220 or e-mail gary@altmanassociates.net.
