A critical of component of any Texas estate plan is ensuring that you keep your beneficiary designations up to date on your life insurance policies and retirement plans. One area of estate planning where people frequently go wrong is neglecting to update beneficiaries, or failing to name beneficiaries, for life insurance proceeds, retirement plans, and Individual Retirement Accounts (IRAs). Although naming or updating beneficiary designations is a simple process, the failure to update them can create additional expense after you die by increasing the cost to administer your estate, and it can also have adverse tax consequences on the ultimate beneficiaries. Having a Will does not by itself avoid these issues. It is crucial that your estate planning contains a procedure to regularly maintain your beneficiary designations.
Many people mistakenly believe that by having a Texas Last Will and Testament, their retirement plans and life insurance policy proceeds will go to the people named as beneficiaries in their will. However, the beneficiaries of life insurance policies, retirement plans, and IRAs are determined by the beneficiary designations that are contained in the contract or plan. As a result, the proceeds from these assets pass outside of your Will and will not be subject to probate unless your estate is named as the beneficiary (which usually is not a good idea).
If you are married, the odds are that your spouse is the default beneficiary of any life insurance policies or retirement plans unless you have named another person or entity (such as a trust) as the beneficiary. In many cases, this may be fine, but it may not always be what you want. For instance, if you are in a second marriage and want to leave life insurance proceeds to children from your first marriage, you will need to make sure that your beneficiary designations reflect this. You could, for example, name your children as beneficiaries of the policy to receive the proceeds in equal shares. In some cases, a better option might be to create a trust inside your Last Will and Testament which names your children as the trust beneficiaries, and then name the trustee of the testamentary trust as the beneficiary of the policy. By doing this, you ensure that the policy proceeds will pass to your children in a manner that protects the proceeds from the creditors of your children.
For 401(k) plans, the importance of updating your beneficiary designations cannot be overstated. If you are divorced in Texas, any beneficiary designations in favor of your former spouse are revoked under Texas law. However, 401(k) plans are governed by the Employee Retirement Income Security Act (ERISA), which is a federal law. Under ERISA, if you are divorced, your former spouse may remain the current beneficiary unless you change the designation. This has proved to be a fatal flaw in more than one estate plan, and the failure to update beneficiary designations for a 401(k) in this case will almost always guarantee that your retirement plan does not get distributed according to your wishes. Additionally, if you have remarried, you should be aware that under any retirement plan governed by ERISA, your spouse is the only permissible beneficiary unless he or she consents in writing otherwise.
For IRAs, incorrect beneficiary designations can mean that your beneficiaries are forced to receive distributions at an accelerated rate, which can result in adverse tax consequences. Generally, your spouse has more options with regards to your IRA. For instance, your spouse can usually rollover your IRA into his or her own IRA and postpone any required distributions until he or she reaches age 70 ½. While this option is not available for other beneficiaries such as your children, other beneficiaries can often treat the IRA as an “inherited IRA” and stretch out the requirement payments over their expected lifetimes. However, if your estate is the beneficiary of your IRA, the options are limited and often results in a lump sum being distributed, which is usually not a good result for income tax purposes.
You should contact your Texas estate planning attorney when certain life events occur in order to ensure that your beneficiary designations are coordinated with your overall estate plan. Some of these events include the following:
As an added precaution, you should also name a contingent beneficiary in case your primary beneficiary or beneficiaries die before you. This will help ensure that the assets pass to your desired beneficiaries rather than allowing the plan’s default provisions to determine who will inherit the assets.