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Estate planning is a critical process that ensures your wealth and assets are passed on to your loved ones as per your wishes after your demise. While there are multiple ways to plan your estate, two common methods include relying on beneficiary designations and setting up a trust. However, while beneficiary designations might seem like a simple and straightforward solution, relying on them exclusively can lead to several complications.
The Appeal of Beneficiary Designations
Beneficiary designations are a popular choice because they are easy to set up and typically bypass the probate process. They are commonly used with assets like life insurance policies, retirement accounts, certain types of bank accounts, and vehicles. However, there are significant risks associated with relying solely on beneficiary designations.
1. Inflexibility of Beneficiary Designations
Beneficiary designations are a somewhat fixed method of estate planning. Once you designate a beneficiary for an asset, that person is the one who will inherit it, with few exceptions. This method does not account for changes in circumstances or unexpected events. If your primary beneficiary passes away before you and no contingent (or secondary) beneficiary is named, the asset in question will not automatically go to another loved one or heir. Instead, it may end up in probate court, a time-consuming and often costly process that can cause significant stress for your loved ones.
2. Limited Control of Asset Distribution
Moreover, the rigidity of beneficiary designations does not allow for flexibility in terms of the timing or conditions of the asset distribution. Unlike a trust, which can specify conditions such as the beneficiary reaching a certain age or achieving a specific milestone before receiving the asset, beneficiary designations offer no such control. Once the asset is transferred to the beneficiary, there are no restrictions on how they use it. This can be particularly concerning if the beneficiary is a minor, has special needs, or is not financially responsible.
Furthermore, if you have multiple beneficiaries, each beneficiary’s share may not reflect your original intent if any of them pass away before you. Unless otherwise specified, the deceased beneficiary’s share will usually be distributed among the surviving beneficiaries, which might not align with your original wishes.
3. Probate Avoidance
The most common reason an asset with a beneficiary designation ends up in probate is the lack of a contingent (or secondary) beneficiary. If the primary beneficiary passes away before or simultaneously with the asset owner and no contingent beneficiary has been named, there’s no one to transfer the asset to, forcing it to go through probate. Furthermore, if the beneficiary is a minor or legally incapacitated at the time of the asset owner’s death, the court may need to get involved to protect the beneficiary’s interests, which could mean a probate process. In these cases, the court will often require a guardianship be established for the minor or incapacitated beneficiary to receive the asset, which can be extremely time-consuming and costly.
4. Beneficiary Designations Offer No Asset Protection
Assets with beneficiary designations are not protected from the owner’s creditors. If the owner incurs significant debts or liabilities, these assets can be seized to satisfy those obligations. Even though the assets are intended to pass to the designated beneficiary upon the owner’s death, they remain fully accessible to creditors during the owner’s lifetime. Similarly, if the owner is sued and a judgment is rendered against them, assets with beneficiary designations can be used to satisfy those judgments. In a divorce, assets with beneficiary designations can be considered part of the marital estate and, therefore, may be subject to division, further depleting your beneficiaries’ inheritance.
5. No Protection from Beneficiaries’ Creditors
When assets are transferred through a beneficiary designation, they become immediately available to the beneficiary’s creditors. For example, if a beneficiary is dealing with bankruptcy or has substantial outstanding debts, the inherited assets can be seized to satisfy those obligations. In contrast, assets placed in certain types of trusts can be shielded from the beneficiary’s creditors.
Furthermore, beneficiary designations offer no provisions to prevent a beneficiary from squandering inherited assets irresponsibly. Once the assets are transferred, the beneficiary has full control over them. This can be a particular concern if the beneficiary is prone to poor financial decisions or is easily influenced by others.
6. Potential Impact on Beneficiaries Qualifying for Government Assistance Programs
For beneficiaries who are receiving needs-based government assistance, inheriting assets directly through a beneficiary designation could disqualify them from continuing to receive those benefits. Certain types of trusts, such as a Special Needs Trust, can be designed to prevent this, allowing the beneficiary to inherit while still retaining their eligibility for assistance.
While beneficiary designations can be a useful tool within a broader estate plan, there are many pitfalls to relying on them as your sole estate planning device. A comprehensive estate plan that includes trusts and other tools can provide the necessary protections and ensure that your assets are passed on to your loved ones in the most beneficial way. At Pierce Legal, we get to know each of our clients, gaining a meaningful understanding and relationship with you. This allows us to create a thorough estate planning strategy that will satisfy all of your planning goals and needs. Contact us today to schedule a consultation at (330) 588-6115.