Many individuals assume that once they have updated their Last Will and Testament or other testamentary instrument, their estate plan is complete. There is one important item that needs to be addressed frequently, even after executing a Will – beneficiary designations. Accounts that are joint with another individual, or payable/transferable on death are non-probate assets, and thus, do not pass in accordance with the decedent’s testamentary instrument; rather, they pass to the surviving account holder, in the case of a joint account with right of survivorship, or to the beneficiary stated on the account’s beneficiary designation form. Insurance policies, retirement accounts and certain bank/brokerage accounts with a “Payable of Death” or “POD” designation typically have beneficiary designation forms which direct who will inherit the assets in an account upon the owner’s death, regardless of what the owner’s Will states. For many individuals, their retirement account(s) comprises the majority of their accumulated wealth, and thus a periodic review of the beneficiary designation form is critical to one’s testamentary plan, particularly when facing a major life event such as divorce, remarriage, birth of a child, or the death of a beneficiary.
Spouse Designation
In the case of a divorce, many states, including New Jersey, have legislation providing that any beneficiary designation in favor of a former spouse is revoked upon divorce. It should be noted, however, that the automatic revocation provided for in the New Jersey statute only applies in the event of a judgment of divorce by a court or annulment, not if the parties are merely separated. In New Jersey, there are exceptions to the automatic revocation; for example, when the divorcing spouse’s property settlement agreement requires one spouse to maintain a life insurance policy and designate the ex-spouse as the beneficiary, or if the governing instrument provides otherwise.
Trust for Child
When creating an estate plan, many individuals set up a trust for a minor child or other beneficiary who needs spendthrift protection, but then designate the same beneficiary on an account. Upon the account owner’s death, the proceeds of the account would go to the beneficiary outright, rather than the trust created by the account owner, thus circumventing the goal of the trust. To prevent this, the account owner should designate a trust as the beneficiary of the account in order to maintain some control over the disposition of the assets after he or she dies. However, there are special steps that must be taken when a trust is designated as the beneficiary of an IRA account to ensure that the designation does not create unintended income tax consequences for the parties who will inherit the assets.
IRAs
An Individual Retirement Account has special considerations worth discussing. When an IRA passes to a surviving spouse, said spouse can simply roll over the inherited IRA to his or her own account. For other beneficiaries, the account should be split up, thereby permitting each beneficiary to use his or her own life expectancy to take required minimum distributions each year, prolonging the tax-deferred growth on the bulk of the inherited assets. However, there are steps that must be taken and strict timeframes that must be adhered to, in order to set up an inherited IRA successfully. Specifically, the beneficiaries would need to make sure that the account is divided amongst the stated beneficiaries by December 31 of the year following the original IRA owner’s death. Failure to do so would result in accelerated income tax consequences and much of the benefit of the tax-deferred vehicle would be lost. Parents can prevent this by setting up separate IRA accounts and designating a different child on each account’s beneficiary form.
Typically, a beneficiary designation form for an IRA account permits the owner to choose a primary beneficiary or beneficiaries, as well as contingent beneficiaries, who would inherit an account if the primary beneficiary was deceased. If the primary beneficiary was deceased and a contingent beneficiary was not named, or if no beneficiary was designated at all, the proceeds would most likely be distributed to the account holder’s estate if no plan document provides otherwise. This is not a desirable result, however, because not only would the funds become subject to the decedent’s creditors, but there could be unintended income tax consequences for the decedent’s heirs.
It is important to periodically review your beneficiary designations to coordinate with your overall estate plan, but a review is crucial when your life circumstances change such as in the event of marriage, divorce, birth of a child or the death of a spouse. If you fail to do so, your designated beneficiaries may no longer reflect your current wishes. The custodian of the account is required to distribute the property to the beneficiary you have named, regardless of what your Last Will and Testament may direct. Additionally, there is always an added concern with the mergers and consolidations of banks, insurance companies and financial institutions, that a beneficiary designation form you believe is on file and sufficient for your intended was lost or inadvertently destroyed. Always keep copies of your beneficiary designations and account titles with your estate planning attorney and with your personal records.
Nicole E. Russak is an Associate Attorney who actively practices in our Tax, Trust & Estate Department, and also in Corporate, Commercial and Real Estate areas.