Bequeath or Beneficiary: In Estate Planning, the Difference is Crucial

By: Jan Paul C. Ferrer

When planning your estate, be sure you understand the differences between bequests made in your Last Will and Testament and beneficiary designations for retirement plans, IRAs and investment accounts. The scenario plays out over and over again in attorneys’ offices: A family brings a parent’s Last Will and Testament (the “Will”) to be probated. The Will is complete and well thought out, and it takes into consideration current tax law. But under closer examination, the attorney discovers that the deceased’s estate plan doesn’t work. Why? Because a substantial portion of the parent’s assets pass under a beneficiary designation. Any asset that has a beneficiary designation is a non-probate assets and is not controlled by the Will.1 Increasingly, investors have the opportunity to name beneficiaries directly on a wide range of financial accounts, including employer-sponsored retirement savings plans, IRAs, brokerage and bank accounts, insurance policies, U.S. savings bonds, mutual funds and individual stocks and bonds.2 The upside of these arrangements is that when the account holder dies, the monies go directly to the beneficiary named on the account, bypassing the sometimes lengthy and costly probate process (although such assets are still included in the deceased’s estate for estate tax purposes). The downside, however, is that beneficiary-designated assets pass “under the radar screen” and without regard to the directions spelled out in a Will. This all too often leads to unintended consequences–individuals who you no longer wish to inherit property will receive property , and some individuals will receive more than intended and some will receive less; ultimately, there may not be enough money available to fund the bequests laid out in the Will. Consider the following hypothetical scenario: John has $600,000 in property that he intends to pass equally among his three children under his Will. John also has a life insurance policy for $150,000 that names only one of his children as the sole beneficiary. When John dies, that one child will inherit all of the life insurance money ($150,000) and one-third ($200,000) of the assets passing through John’s Will. So instead of each of John’s children receiving $250,000, one of them receives $350,000 and the other two each receive $200,000. John’s plan under this Will and his intent to treat all of his children equally has been defeated because John never updated the beneficiary designation on the insurance policy make all of his children equal beneficiaries of the insurance policy. . The same result would occur even if John’s Will had specifically stated that the life insurance policy should be shared equally, because the Will is not an effective way to amend a beneficiary designation. A beneficiary designation always overrides any instructions included in a will. Unnamed or Lapsed Beneficiaries Not naming beneficiaries or failing to update forms if a beneficiary dies can have unintended repercussions. For instance, a recent case that came before the U.S. Supreme Court illustrated how a simple beneficiary form review could have prevented undue stress and bitter divisions for one family. Specifically, in Hillman vs. Maretta, the Court ruled in 2013 that a decedent’s ex-spouse, who was still named as his beneficiary, was entitled to receive his federal life insurance benefits. The unanimous decision came despite the fact that an applicable state law specified that a divorce removes an exspouse as the beneficiary of a decedent’s various death benefits.3 While this case was centered on the proceeds of an insurance policy, similar, equally unfortunate scenarios caused by poor planning or benign negligence could affect IRA and other retirement account beneficiaries. For instance, if the beneficiary of an IRA is a spouse and he or she predeceases the account holder and no contingent (second in line) beneficiary(ies) are named, when the account holder dies, the IRA will then be paid pursuant to the default beneficiary provisions set forth in the IRA Agreement governing the IRA. The default beneficiaries will vary among IRA providers and you should determine the default beneficiaries under your IRA provider’s IRA Agreement. If the default beneficiary of the IRA is your estate, this would prevent your children from stretching IRA distributions (and tax-deferral benefits) out over their lifetimes Planning Priorities Given these very real, very preventable consequences, it is important to take steps to assure consistency between your beneficiary- designated assets and the disposition of property as it is spelled out in your Will. First, make sure to communicate your plans and designations to family and beneficiaries, especially if you are making unequal distributions. This can help avoid potential conflicts between beneficiaries. Second, you should review your beneficiary designations on a regular basis–at least every few years–and/or when certain life events occur, such as the birth of a child, the death of a loved one, a divorce or a marriage, and update the designations , as necessary, in accordance with your wishes. Lastly, make sure to keep thorough records so that it is clear to the executor what assets have beneficiary designation and what assets should be disposed according to the terms of your Will. Contact me for help in creating an estate plan or bringing your existing estate plan in line with your current wishes for the disposition of your assets. Footnotes/disclaimers: 1Source: Financial Planning Association, “Don’t Forget to Audit Your Beneficiary Designations,” , May 23, 2011. 2Source: The CPA Journal, “Coordinating Wills with Beneficiary Designations,” November 1, 2002. 3Source: Financial- Planning.com, “Beneficiary Form Trumps Divorce in High Court Ruling,” November 1, 2013. 4Source: SeniorLaw.com, “Ten Biggest Mistakes You Can Make in Your Estate Plan,” November 1, 2013. Morgan Stanley Smith Barney LLC (“Morgan Stanley”), its affiliates and Morgan Stanley Financial Advisors or Private Wealth Advisors do not provide tax or legal advice. This material was not intended or written to be used, and it cannot be used, for the purpose of avoiding tax penalties that may be imposed on the taxpayer. Clients should consult their tax advisor for matters involving taxation and tax planning and their attorney for matters involving trust and estate planning and other legal matters. If you’d like to learn more, please contact Jan Paul Ferrer. Article by Wealth Management Systems Inc. and provided courtesy of Morgan Stanley Financial Advisor. The author(s) are not employees of Morgan Stanley Smith Barney LLC (“Morgan Stanley”). The opinions expressed by the authors are solely their own and do not necessarily reflect those of Morgan Stanley. The information and data in the article or publication has been obtained from sources outside of Morgan Stanley and Morgan Stanley makes no representations or guarantees as to the accuracy or completeness of information or data from sources outside of Morgan Stanley. Neither the information provided nor any opinion expressed constitutes a solicitation by Morgan Stanley with respect to the purchase or sale of any security, investment, strategy or product that may be mentioned.##