Q. Last week, you wrote about why inheritance sometimes goes unclaimed, and how it’s a lot less likely when you have a trust in place. I read something about the downsides of beneficiary designations naming individuals and how they do not always solve the problem of probate and can actually cause many more problems than they solve. Can you explain why this happens and actions to take to avoid this? Thanks so much for your help!
A. You mentioned last week’s article. That was Part 1 of this series and readers can find that by clicking here. The following answer to your question is excerpted from the recently-released third edition of one of my Amazon Best-Selling books, “How to Protect Your Assets from Probate PLUS lawsuits PLUS Nursing Home Expenses with the Living Trust Plus®”:
Most people are familiar with beneficiary designations, and many people attempt to use beneficiary designations as an informal way to avoid probate. But, as you mentioned, beneficiary designations can cause more problems than they solve.
What Are Beneficiary Designations?
Some types of assets can be titled with a named beneficiary — someone who is entitled to receive the assets directly after the death of the owner. Insurance policies and retirement plans use the term “beneficiary,” but depending on the type of asset involved, a beneficiary designation may be called something different. For example, most banks use the term “POD” (which stands for “Pay on Death”) for bank accounts and Certificates of Deposit. The Federal Government uses the term POD for Savings Bonds and other Treasury instruments.
Securities (stocks, bonds, and brokerage accounts) typically use the term “TOD,” which stands for “Transfer on Death.” Regardless of the specific nomenclature used, all beneficiary designations work essentially the same way.
How Do Beneficiary Designations Work?
If you’re the owner, you retain complete control of your asset while you’re alive, and you can change the named beneficiary at any time during your life, so long as you remain competent. If you become incompetent, and you have a comprehensive power of attorney drafted by an experienced elder law attorney, then your agent under your power of attorney will be able to change the beneficiary designation while you are incompetent, so long as this specific power is granted to your agent in the power of attorney. This specific power is important to be in a power of attorney so that your agent can name a new beneficiary if the one you have named predeceases you, so that the asset does not wind up going into probate and being stuck in probate potentially for many years. After your death, the named beneficiary must fill out a claim form and file it with the financial institution, along with a death certificate showing proof of your death. Upon acceptance of the claim, the idea is that the financial institution distributes the asset to your named beneficiary. This distribution is typically intended to pass directly to the named beneficiary outside of probate, but, as we’ll see, it doesn’t always work out the way it’s intended.
Problems with Beneficiary Designations
Because of numerous potential problems with beneficiary designations, we don’t generally recommend them to clients as a means to avoid probate. The following are some of the problems we have seen with beneficiary designations:
- Beneficiary Designations Don’t Work for All Types of Assets: Not all assets can be titled with a beneficiary designation. In most states, cars and real estate cannot be owned with a beneficiary designation. Many financial institutions don’t offer POD or TOD accounts. Tangible personal property — e.g., home furnishings, jewelry, etc. — is not generally capable of being titled with a beneficiary designation, as such items do not generally have any documents of title establishing ownership. Since not all assets can be titled with a beneficiary designation, if you try to avoid probate by using beneficiary designations, some assets will typically still have to go through probate.
- Beneficiary Designations Are Tedious to Change: There is no single document where you can simply list your assets and declare them “payable on death.” To establish a beneficiary designation for each asset, you must fill out a separate beneficiary designation form at every financial institution holding your assets. And you must be careful to list every single account you wish to have designated beneficiary added to. Every asset that you wish to make “payable on death” has to be individually changed. If you later wish to change your beneficiary designations, you must change each one individually all over again.
- Beneficiary Designations Don’t Work for Minors: Beneficiary designations should never intentionally be used as a way to distribute assets to minors, because children under the age of 18 are not legally allowed to control assets. If a minor does inherit assets, those assets will either have to be held by the court and unused until the minor turns age 18, or be held in a court-supervised “living probate” requiring detailed record-keeping, annual accountings, and all the other complications, hassles, and expenses of after-death probate. Either way, the money will need to be distributed to the minor at age 18, and most people do not want large sums of money falling into the lap of an immature 18-year-old whose brain is not going to be fully developed until age 25.
- Beneficiary Designations May Not Work if a Beneficiary Predeceases You: If a named beneficiary dies before you, that beneficiary’s share will typically “lapse,” meaning that the share of that beneficiary will go to your estate, and therefore through probate, where it will eventually be distributed under the terms of your Will (if you have one) or under the laws of intestacy for your state of residence. Or maybe you have an alternate beneficiary named if your named beneficiary dies before you. But the problem there is that the alternate beneficiary is often the primary beneficiary’s minor child(ren), meaning those funds are going to wind up in the court or in living probate as just explained in the preceding paragraph.
- Beneficiary Designations Don’t Work for Disabled Beneficiaries: Beneficiary designations should almost never be used as a way to distribute assets to disabled beneficiaries, for several reasons. First, the inheritance will wind up getting stuck in probate if the disabled beneficiary has been adjudicated to be legally incapacitated and therefore unable to manage assets. Worse, a direct inheritance may disqualify a disabled beneficiary from receiving certain vital public benefits, such as Medicaid and SSI. The proper method for taking care of a beneficiary who is disabled is through a Special Needs Trust.
- Beneficiary Designations Don’t Work if Your Beneficiaries Don’t Know About Them: Beneficiary designations must be made known to all of your named beneficiaries or they won’t know to claim your death. Suppose you have named beneficiaries who don’t know they’re named or don’t know the exact financial institution or the account numbers. In that case, they may never be able to make a claim and the money may eventually be paid to the state’s unclaimed property fund. Much if not most of the money sitting in every state’s unclaimed property funds is there for this exact reason — unclaimed inheritance because the named beneficiaries weren’t aware of the asset or weren’t aware they were the named beneficiaries of the asset. See last week’s article.
- According to Barron’s, as of February 2020, there were nearly $100 billion in unclaimed funds in the United States, and most of this money presumably comes from accounts that had named beneficiaries who failed to make a claim. A related problem is the incredible awkwardness of telling a named beneficiary that you have changed your mind and named a new beneficiary.
- Beneficiary Designations Don’t Work if Your Beneficiaries Don’t Have Access to Your Death Certificate: Beneficiary designations might be useless if your named beneficiaries don’t have access to your death certificate, which is a frequent occurrence.
- Beneficiary Designations Can Be Disastrous if Your Estate has Unpaid Bills: If all of your assets were to actually successfully transferred to your named beneficiaries upon death, what happens to the legitimate bills owed by your estate? What might happen is that one of you beneficiaries opens an estate and finds that the other beneficiaries who received their inheritance are not willing to give money to the estate to pay your debts. Alternatively, a creditor of yours might open an estate for you and then sue one or more of your beneficiaries to try to force them to pay their inheritance to your estate in order to pay your legitimate creditors.
As you can see, because of the problems mentioned above, we typically do not recommend beneficiary designations if those named beneficiaries are going to be individuals.
Naming a Trust as a Beneficiary
When a trust is named as the beneficiary, the trust inherits the asset when the owner dies. In today’s Critter Corner, we use an IRA as an example. A trust can be named as an IRA beneficiary, and in many instances, a trust is a better option than naming an individual. When the trust inherits the IRA, it is then maintained as a separate account that is an asset of the trust. There are many advantages to this, as we explain here.
Plan in Advance for Yourself and Your Loved Ones
When it comes to estate planning, including setting up trusts, the Farr Law Firm helps individuals of all ages in all situations plan for themselves and their loved ones. By planning properly in advance, you can avoid the chaos of having no unified estate plan or having some or all of your assets go through probate, and you can retain the assets it has taken a lifetime to accumulate and the peace of mind that your family’s needs will be adequately and properly addressed. If you or members of your family have not done Incapacity Planning, Estate Planning, or Long-term Care Planning, or if a loved one is beginning to need more care than you can handle, please contact us to make an appointment for an initial consultation:
Estate Planning Fairfax: 703-691-1888
Estate Planning Fredericksburg: 540-479-1435
Estate Planning Rockville: 301-519-8041
Estate Planning DC: 202-587-2797
About Evan H Farr, CELA, CAP
