“Nonprobate assets” are those that bypass more traditional estate planning vehicles, such as a will or revocable trust. Instead, they’re transferred to family members through beneficiary designations. Nonprobate assets can include IRAs and certain employer-sponsored retirement accounts, life insurance policies, and some bank or brokerage accounts.
If you’ve designated beneficiaries for certain assets, it’s critical to review your choices periodically. This is especially important after a major life change, such as a divorce or the birth of a child or grandchild.
Conduct your review
As you review your beneficiary designations, consider the following best practices:
Name a primary beneficiary and at least one contingent beneficiary. Without a contingent beneficiary for an asset, if the primary beneficiary dies before you — and you don’t designate another beneficiary before you die — the asset will end up in your general estate and may not be distributed as you intended. In addition, certain assets offer some protection against your creditors, which would be lost if they were transferred to your estate. To ensure that you control the ultimate disposition of your wealth and protect that wealth from creditors, name both primary and contingent beneficiaries and avoid naming your estate as a beneficiary.
Update beneficiaries to reflect changing circumstances. Designating a beneficiary isn’t a “set it and forget it” activity. Failure to update beneficiary designations to reflect changing circumstances creates a risk that you will inadvertently leave assets to someone you didn’t intend to benefit, such as an ex-spouse.
It’s also important to update your designation if the primary beneficiary dies, especially if there’s no contingent beneficiary or if the contingent beneficiary is a minor. Suppose, for example, that you name your spouse as primary beneficiary of a life insurance policy and name your minor child as contingent beneficiary. If your spouse dies while your child is still a minor, it may be advisable to name a new primary beneficiary — such as a trust — to avoid the complications associated with leaving assets to a minor (court-appointed guardianship, etc.). Note that there are a lot of nuances to consider when deciding to name a trust as a beneficiary.
Consider the impact on government benefits. If a loved one — for example, a disabled child — depends on Medicaid or other government benefits, naming that person as primary beneficiary of a retirement account or other asset may render him or her ineligible for those benefits. A better approach may be to establish a special needs trust for your loved one and name the trust as beneficiary.
Keep an eye on tax developments. Changing tax laws can easily derail your estate plan if you fail to update your plan accordingly. For instance, the SECURE Act, enacted in 2019, sounded the death knell for the “stretch” IRA.
Previously, when you left an IRA to a child or other beneficiary (either outright or in a specially designed trust), distributions could be stretched over the beneficiary’s life expectancy, maximizing tax-deferred savings. But the SECURE Act requires most nonspousal beneficiaries of IRAs to distribute the funds within 10 years after the owner’s death. In light of this change, you should review the designated beneficiaries for your IRAs and other retirement accounts.
Align your estate planning goals
No matter how carefully you plan your estate, your objectives can easily be thwarted by inappropriate beneficiary designations for nonprobate assets. Avoid unintended consequences by reviewing your beneficiary designations regularly to make sure they’re still appropriate and that they align with your overall estate planning goals. Contact your estate planning advisor to help you determine if you need to make any changes to your current estate plan.