I write often on this blog and in the Side by Side Planner about how important beneficiary designations are to an estate plan. They are the secret keys to creating a plan that really works, a plan that is easy for your loved ones to carry out, that reflects your true wishes and values, and that happens in a timely manner.
Because I write about this so often, I want to caution you that beneficiary designations are not the perfect tool. They require delicate handling and often the advice of a professional attorney. There are several things that can go wrong when all the assets are transferred through this singular method. Let’s explore how beneficiary designations work, what the pitfalls can be, and how you can fix these issues.
How Beneficiary Designations Work
When you create a new account or purchase certain types of insurance, you’re given a place to designate your beneficiary, the person who will inherit the account if you die. Choosing a beneficiary is pretty powerful: the account will transfer to this person without having to go through probate. With proof of death, such as a death certificate, the account transfers automatically.
Some states allow beneficiary forms for vehicles as well, so that a motor vehicle does not count toward the individual’s total assets to determine if they go to probate or not. These forms can be very useful: imagine if you want to pass your car to your grandchild and be sure they get it quickly and without the hassle of waiting for the estate to close. A form like this makes it easy. They simply take the vehicle title, beneficiary designation, and death certificate to the RMV and they can be issued a new title.
Beneficiary designations are separate from probate assets, which are the assets that end up going through probate court, costing money to the estate.
What Qualifies as a Probate Asset?
The dollar amount of an estate that will go through probate differs in each state, but there are a few defining characteristics of an asset that will qualify it as a probate asset:
The asset is owned solely in the name of the deceased person
The deceased has an individual share of a property or other asset owned by tenants in common (this can exist even between spouses)
There is no beneficiary or pay on death designation named for the asset
Depending on the state, all assets above a certain dollar value
When an estate goes to probate, a personal representative is assigned, and the personal representative is responsible for settling the estate and distributing the assets, including funds.
The Dangers of Passing Everything Through Beneficiary Designations
So, you’re thinking, if beneficiary designations are so great, why shouldn’t I use them for every asset?
Imagine if every asset you owned had a beneficiary designation. Upon your death, every asset would be automatically distributed to the different beneficiaries. The estate itself would not have any liquidity to pay for costs or settle specific bequests.
Perhaps in your estate plan, you specified leaving your dog to your neighbor, because the neighbor loves the dog so much and agreed to care for him. You wanted to give the new owner $5,000 from your estate to help offset the cost of the dog and ensure the dog will be taken care of for life.
If all the money immediately transferred out of the estate, the personal representative would be left to seek out the heirs and collect funds from them. They would not be obligated to contribute these funds to the estate, so they might refuse. Whoever received the cash from the life insurance is not obligated to give the $5,000 to pay for the pet. Then, your neighbor might not be able to care for the dog, and have to give it up.
It’s a good idea to choose your beneficiaries and set up designations, but don’t go overboard with making sure every asset transfers this way. There are costs that you might not consider that have to come out of the estate. This could be difficult if the beneficiaries have already inherited the money and are reluctant to part with it.
Whenever you’re thinking about complicated estate planning issues, I encourage you to speak with an attorney who has lots of experience in this area. Without an attorney, you could be leaving your personal representative in a difficult position by taking all the money off the table.