Reminder: Beneficiary Designations
By Jeanne Blackmore, Esq. and Kasey Franzoni, CISP
ONE OF TRUST COMPANY OF VERMONT’S core services is helping clients implement basic estate plans. Typically, a basic estate plan includes a revocable trust to provide for the disposition of assets on death. Revocable trusts are popular because they are useful for estate tax planning in the case of married couples, they allow for creative structuring of dispositive provisions, and they are not subject to probate administration if properly funded during the client’s lifetime. This article focuses on an important aspect of funding a revocable trust: beneficiary designations for retirement accounts.
Funding a revocable trust is fairly straightforward: the title of a client’s assets is changed from his or her name to the name of his or her trust. For example, to title an investment account or a piece of real estate in trust, the legal ownership would be changed from Jane Doe to Jane Doe, Trustee of the Jane Doe Trust. The process would require new account paperwork or a new deed. Once an asset is titled in a trust, the client can be sure that, on his or her death, the successor trustee can immediately administer that asset in accordance with the terms of the revocable trust without the delay of probate administration. Unfortunately, certain types of assets, such as retirement accounts, cannot be titled in trust. Retirement accounts, including 401(k) plans, 403(b) plans, and all types of IRAs, may only pass by beneficiary designation. For this purpose, a beneficiary designation is an agreement between the custodian of a retirement account and the client that, on the client’s death, the custodian will distribute his or her retirement account in accordance with the instructions contained in the beneficiary designation. As such, it is important to make sure that beneficiary designations are in place and up to date.
The most difficult part about putting a beneficiary designation in place is not the paperwork; it is deciding how to structure the beneficiary designation. Often a client designates a spouse as primary beneficiary and children as contingent beneficiaries. This way, on a client’s death, his or her retirement account passes to the surviving spouse or, if the surviving spouse is deceased, to children. However, many clients designate their revocable trust as primary or contingent beneficiary for a variety of reasons. If a client is unmarried and/or does not have children, this is an easy way to pass retirement accounts to the beneficiaries named in the trust. Or a retirement account can be used to fund a credit shelter trust if there are not enough non-retirement assets for that purpose, or to fund a marital trust if the surviving spouse is a second spouse. A client might designate his or her revocable trust as beneficiary in the event a child predeceases and leaves a minor child, or if a child has a continuing trust established under the revocable trust. Some clients have complex beneficiary designations if there are many continuing trusts for family members, or a combination of different types of retirement accounts, or they have a complicated dispositive scheme. In short, while there are common patterns to beneficiary designation structures, all clients have different circumstances, and it is possible to structure beneficiary designations to accommodate a wide variety of fact patterns.
Once a client settles on the structure of the beneficiary designation, it is necessary to make sure it dovetails with the rest of the client’s estate plan, that the paperwork is correctly completed, and that the custodian will respect it. For example, if a trust is designated as beneficiary, the trust agreement must contain certain language to avoid adverse income tax consequences and must also clearly indicate what dispositive provisions apply to the retirement accounts for which the trust is designated as beneficiary. If the retirement account is a 401(k) for any sub-trust that is designated as beneficiary. If a beneficiary designation form cannot accommodate a complex designation, it may be necessary to attach a statement with a detailed explanation.
In all cases, it is important to receive a written confirmation from the account custodian that the custodian will respect a beneficiary designation on the client’s death. When a beneficiary designation fails, whether because it is out of date or rejected by the custodian or just never done, the consequences can be significant. The best case is that the retirement account is unavailable to the client’s intended beneficiaries while the account goes through the probate administration process. The worst case is that the client’s heirs litigate over who inherits the retirement account because probate will produce a different result than what the beneficiary designation appeared to intend.
A majority of Americans age 40 and above have at least one retirement account, and many of those Americans hold a significant amount of their personal wealth in retirement accounts. As such, it is quite important to attend to beneficiary designations with care. Here at Trust Company of Vermont, we are happy to assist clients to structure their retirement account beneficiary designations as part of our overall service offerings, regardless of whether those accounts are in custody with us.