Getting divorced is a stressful process. Facing the prospect of going into a courtroom to divide assets and time with children can force you to look at your life through a new lens. Have you ever considered what will happen to your property if you were to die unexpectedly? What would happen to your children? Have you created the proper documentation that would ensure they would benefit from your years of hard work? It’s time to get your life in order. This often means creating a will or similar plan.

Defining beneficiaries can be a stressful but necessary part of estate planning. Understanding the intricacies of life insurance policies, pension plan accounts, and IRAs is not sexy stuff. Time spent in such efforts is almost certainly always filed under the “Things I Have to Do” column.

But choosing beneficiaries is a very important decision with complicated estate and income tax consequences. In actuality, the whole affair can get quite complex and lawyerly rather quickly.

For example, a will and estate plan are very similar: both are defined as making outright gifts to a certain number of people. Consider the following: a will might name the beneficiary as the spouse and contingent beneficiaries as the children. A simple variation on this kind of arrangement might contain a stipulation of trust where beneficiaries under the age of 25 could not claim what was left to them until the age of 35.

Unfortunately, such arrangements don’t offer any kind of asset protection for the beneficiary. This type of plan can make assets subject to the the beneficiary’s creditors.

Plans that provide creditor protection features usually begin at $1,500 or higher. If you’re looking to create a trust that might escape estate taxes and creditors for years to come and that  number has now risen to approximately $2,500 to start.

Like with most things, the devil is almost always in the details. When naming beneficiaries there are factors that should be considered, including:

  • The age of the person(s) to be included in the policy or plan. Most plans won’t transfer assets directly to minors until a guardian is approved by a court.
  • The beneficiaries ability to effectively manage assets. This, of course, is always a prominent factor for consideration when building a plan that will involve an underage person as the beneficiary. Creating a trust in the person’s name might be the best course of action rather than a direct transfer.
  • When choosing a beneficiary for a pension plan it’s important to note that, unless waived in writing, a spouse is required by law to be the primary beneficiary of such an account.

The key to creating a plan that reflects your intentions and desire is to understanding the overall undertaking. The following is a breakdown of various types of plans and policies.


Life Insurance

Benefit proceeds are always paid out income tax free upon death, and it doesn’t matter who is designated. Instead of property being disposed in a will, beneficiary forms completed correctly insure that proceeds do not go through probate.

When creating your plan, it would behoove you to name a contingent or secondary beneficiary. If the primary beneficiary passes away the trust will then be transferred to the surviving beneficiary.

Should both the first and secondary beneficiaries be deceased, then the beneficiary is generally the “estate of the insured,” meaning that the death benefits end up being probated and distributed based upon the decedent’s last will and testament. Dying without a last will and testament means that the state will designate the beneficiaries.


Pension Plans and Individual Retirement Accounts (IRAs)

For legal reasons, spouses are usually named as the primary beneficiary of a 401(k) or a profit-sharing account. The only way this can be avoided is if said spouse waives that right in writing. Single people who are looking to name a beneficiary are eligible for a tax-free transfer to an individual retirement account. Everyone’s situation is different, and extenuating circumstances may occur. Consider consulting a tax professional to learn more about rules and changes in your situation that could affect the overall plan.


Naming Children Can Create Problems

It’s a natural instinct to name  your children as a secondary beneficiary in any estate plan or will. If your children are over the age of 18, more power to you. However, if your kids are still in diapers it may not be the best initial course of action. Naming a child as beneficiary comes with it’s own unique set of problems. Often times, insurance companies, pension plans, and retirement accounts will not pay death benefits to minors. The process is usually such that the benefits are held until such time that they could be placed with a  court-approved guardian and/or trustee of the child’s trust. Specifying a guardian, trust, or trustee is the best bet for creating a competent management scenario of the proceeds for the children. For example, naming a children’s trust as the beneficiary is smart because the proceeds could be invested and managed according to your will and desire.

It’s important to note the IRS regulations are subject to change, and seeking counsel on such matters is advised. Currently, non-spousal beneficiary plans are allowed  to annuitize retirement plan distributions over the life of the beneficiary. Such options may vary depending upon your employer. Ask if this is an option under your plan prior to naming a child. A competent financial advisor might also be able to provide valuable insight into this effort.


Keep Your Plan Up-to-Date

When completing any kind of legal living document (which basically means that it can change as long as you are living) including estate plans and wills, it is advised to regularly check beneficiary designations so that your overall estate plan or will accurately reflects your desire for the distribution of assets. Unfortunately, outdated beneficiary designations (for example: a former spouse or deceased parent) could create an unintended situation in the event of your untimely demise. Also, it’s important to bear in mind that beneficiaries are paid only under the name designated in the legal document. Should a name change for any reason, the new information would need to be added to the document as soon as possible. If you first created your will when your kids were in the third grade and they are now graduating from college, it’s time to update your documents. When undertaking the task of estate planning, it’s a worthy investment to have a lawyer present for consultation so that you understand what you’re doing. It’s easy to get bogged down with legal jargon.

The best way to protect your future beneficiaries is to ensure that you have seen to all of the details in the process, and that the final documents align with your overall goals.

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