Beneficiary Disasters – And How to Avoid Them

ByThomas R. Kestler

Do you know who your beneficiary is? Are you sure?

Assets held in certain vehicles like retirement accounts, IRAs, annuities, and life insurance, all require a beneficiary designation. Beneficiary distributions from these types of accounts are contractual and cannot be modified by a will or trust. All too often, a beneficiary is chosen at the time an account is established and then ignored.

Here are a couple examples of what can go wrong if you’re not paying attention.

The Ex-Factor

Robert started work at IBM 20 years ago. He completed his hiring paperwork, naming Deborah as beneficiary on his 401k and group term life insurance. Robert and Deborah were divorced over 10 years ago. He and his new wife, Emily, were married several years later and now have 2 young children.

While driving home from a late night at work, Robert’s car was hit by an uninsured drunk driver. Emily was devastated. When she finally got around to contacting the IBM HR department, she learned that Deborah was still the named beneficiary of his $100,000 group term life policy and his $450,000 401k account. Emily inherited a house with a big mortgage, two auto loans, and a small savings account. Deborah was laughing all the way to the bank.

The Dis-Inherited Grandkids

Sarah, an 80-year-old widow with three adult children and six grandchildren (2 by each of her children), is the owner of an IRA worth $1,200,000. When the account was opened, she named Peter, her now deceased husband, as primary beneficiary, and “all children equally” as contingent beneficiaries. She never updated her beneficiary designations. Sarah’s middle son, Steve, died from an aggressive form of cancer two years ago. Unfortunately, at Sarah’s death, Steve’s wife and two children will receive none of the proceeds from her IRA. Her surviving two sons will receive $600,000 each. Steve’s widow and two of Sarah’s grandchildren received nothing.

Understanding how assets are distributed at your death is the first step in avoiding disasters.

There are basically three channels through which your assets will travel upon your death.

1. By Contract – Life insurance, annuities, IRAs, 401k plans, etc. will all pass by contract, which means the beneficiary designations supersede everything else and proceeds pass directly to the named beneficiaries. These assets bypass probate and are not controlled by a will or trust.

2. By Will – The executor of the will identifies all assets (outside of those passing by contract) and pays all final expenses. They then file the final tax return and distribute the remaining assets as specified by the will.

3. Intestate – If someone dies without a will (intestate), an executor will be appointed by the court, usually for a significant fee. The executor then performs the same duties as above. However, they are required to distribute remaining assets according to the state’s intestate laws which may not come close to the desires of the deceased.

Although the information above is an oversimplification of what can be a very complex process, the point is, you should work with qualified professionals to put a formal plan in place.

How to Avoid Beneficiary Disasters

1. Do a thorough beneficiary review regularly. Also, consider a beneficiary review after any major life changes – Death in the family, divorce, new children or grandchildren, marriage, adoption, etc.

2. Consider lifetime gifts. If you have more than enough for your own needs, work with an advisor to create a lifetime gifting strategy. This not only reduces the size (and taxation) of a significant estate, but it also allows you the opportunity to see your gifts in action. On the other hand, if you have helped one of your children disproportionately – like providing a downpayment for a house – You may want to adjust the amount of their inheritance down the road.

3. Be specific with beneficiary designations. In the example above, Sarah unintentionally disinherited two of her grandchildren. This could be avoided by using a single term. If you designate individual beneficiaries or use wording like “all children equally”, proceeds are distributed per capita (per head). This means proceeds are divided by the number of living beneficiaries. Per capita is the default assumed distribution method. The simple addition of per stirpes (by roots or by branch) in a beneficiary designation would have avoided Sarah’s problem above. If this one term was added to the contingent beneficiary designation, Steve’s surviving siblings would have received $400,000 each, and Steve’s two children would have received $200,000 each.

4. Work with an estate planning attorney to draft will and trust documents. Be sure to name a qualified individual or institution as the executor. This job involves quite a bit of work and often surviving family members don’t have the time, training or temperament to do the job well.

5. Consider naming an institutional executor. Although this will increase the cost of estate settlement, it will decrease the risk of sibling rivalries during the process. For example, if one child is named executor, the other children may perceive favoritism. On the other hand, if all three of your children are named as co-executors in order to avoid perceived favoritism, you may be creating even greater issues. First, all three must agree on any decision (When have all your children ever agreed on anything?) Second. Anything requiring a signature will need to be circulated all over the country to satisfy the requirement. And, there will be a lot of forms requiring a set of signatures.

Now, back to my original question… Do you know who your beneficiaries are? Are you sure?

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Tom Kestler has been involved in the financial planning field for over 45 years. He is a graduate of Millersville State University and the College for Financial Planning in Denver, Colorado (for which he has acted as an adjunct instructor) and carries the Certified Financial Planner (CFP) designation.

He has also been awarded the Chartered Life Underwriter (CLU), Chartered Financial Consultant (ChFC) and Chartered Mutual Fund Counselor (CMFC) designations from the American College in Bryn Mawr, PA. He was the founder of Kestler Financial Group, Inc., a firm which specialized in the marketing of financial products and services to over 5,000 independent representatives throughout the United States. Kestler Financial Group was acquired by Highland Capital in 2018.

Mr. Kestler carries Life, Health and Variable Products licenses in several states and provides consulting services to insurance companies on product design and development. He also acts as an expert witness in securities and insurance litigation cases.

Prior to his retirement, Tom served as VP Advanced Sales at Highland Capital, and also CEO of Branch Development Partners, an Office of Supervisory Jurisdiction (OSJ) for Securities America, Inc. (now Osaic), an independent securities broker/dealer.

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