Last week, we discussed what you should do if you were named a joint owner on an account or real estate, and your joint owner died. This week we are going to talk about named beneficiaries.
Let’s say that Mom, Dad or another loved one has passed away. You were named a beneficiary on a life insurance policy or annuity. Maybe your loved one named you as a payable or transfer on death beneficiary of a bank or brokerage account. You could also have been named as a beneficiary of a retirement plan such as an IRA or 401(k). Or one of your siblings was named as a beneficiary on some of Mom or Dad’s accounts and Mom or Dad told your sibling to share the account with you and your other siblings. What are your rights and obligations and how do you get your money?
A beneficiary designation is simply a contract. It is a contract that is between the owner of the account and the holder of the funds. The holder could be a bank, credit union, life insurance or annuity company, IRA or other retirement plan custodian. The holder of the funds agrees distribute the funds according to that contract upon the owner’s death. There is no standard beneficiary form. Every financial services company’s beneficiary form is different and a company’s forms could be different between different departments. The account owner has an itty bitty box to put all of the beneficiary instructions on the form. The rest of the contract is governed by all the fine print in the form or account agreement.
What if you the beneficiary died before the account owner. Sometimes the form has it going to the other named beneficiaries. Other beneficiary forms direct that it goes to your descendants, or your heirs, which includes your spouse and descendants. Still other forms have it going to your estate, which would go through probate. I have even seen forms that says it goes back to the owner’s estate, which also has to be probated.
Once you receive your share as a beneficiary, it is legally yours. You do not have to share it with anyone, even if Mom or Dad said to share it with your siblings. If Mom or Dad wanted to make sure it would be divided up, they need to put that in writing in the beneficiary form, or have the beneficiary funds go through their estate or trust to be divided in accordance with the instructions in the will or trust.
Unless the beneficiary is the deceased’s estate or trust, the beneficiary proceeds will bypass the will and trust and all of the instructions in the will and trust will be ignored. If you have a will or trust and want the proceeds to go in accordance with those instructions, you must make sure that your assets with beneficiaries name the estate or trust as the primary beneficiary.
If you are a beneficiary of a life insurance policy, you will first need to contact the life insurance company, usually by phone. Some insurance companies already have a copy of the death certificate through the state and will take your claim over the phone. Others will send you a lengthy claim form which you need to fill out and send back to the company with a certified copy of the death certificate.
Most life insurance companies will give you two options to get your money, either keep the proceeds at the company which you can access with a checkbook that they give you, or receive the entire proceeds via check or electronic funds transfer. Some life insurance companies will require you to initially keep the proceeds with them and the only way that you can access the proceeds is to write yourself a check. Others will only give you a lump sum via check or electronic funds transfer. When the funds are released from the policy to you, they typically come to you income tax free.
Annuities will be governed by the annuity contract. You as a beneficiary will have the options in the contract. Some annuities will allow you to continue the annuity, while others will require an immediate payout. In most cases, when you contact the company, they will send you a lengthy claim form to complete and return to them with a certified copy of the death certificate. Since annuities are tax deferral devices, typically a portion of the withdrawals will be taxable. The annuity company usually tells you the taxable amount and you are given an opportunity to request federal and state withholding on your withdrawal.
With bank and credit union payable or transfer on death beneficiary accounts, all you generally need to do is to go to the bank or credit union with a certified copy of the death certificate and a picture ID. They usually will then give you your money income tax free via check or have you open a new account to hold the cash.
As a beneficiary of brokerage and other marketable securities accounts, you are generally given two options, either sell all of the stocks, bonds, etc. and get cash, or transfer of all of the securities into a new account in your name. When the securities are sold, either right away or later, you generally only pay capital gains taxes on the increase in value since the date of death. All of the increase in value up to the date of death usually never gets taxed.
If the securities account is held by a local broker or financial institution, all you typically need to do is go to the company with a certified copy of the death certificate and picture ID and they will prepare the paperwork for you to sign to get your securities or cash. If it is an online or out-of-town account, you usually have to call them to get a lengthy claim form and other documents that you need to fill out. You return the forms with a certified copy of the death certificate to get your securities or cash.
Similarly with IRAs and other retirement accounts, if the account is held by a local company, go to the company with a certified copy of the death certificate and picture ID and they will usually prepare the paperwork for you to sign to get your funds. If it is an online or out-of-town account, you usually have to call them to get that lengthy claim form and other documents that you need to fill out and return with a certified copy of the death certificate to get your funds.
With the exception of Roth accounts, most IRAs and other retirement accounts are 100% taxable to you the beneficiary as ordinary income. This is because they are pre-tax dollars that were never taxed to the deceased during lifetime. IRAs and most retirement accounts will let you take the proceeds of the account over your life expectancy so you can “stretch-out” the distributions and corresponding income taxes over a period of time. If you do not elect a stretch-out, you generally have to take out the funds within five years of the date of death.
If you are the beneficiary of an IRA from your spouse, you generally have the option of rolling that IRA over into your own name instead of a beneficiary IRA. There are two major benefits of a spousal rollover IRA vs. a beneficiary IRA. Firstly, your own spousal rollover IRA is protected from your creditors, whereas a beneficiary IRA is not. Secondly, if you are under age 70½, you do not have to take distribution from the spousal rollover IRA until age 70½. With a beneficiary IRA, you generally have to start taking distributions within a year of the date of death, regardless of your age.
Banks and other financial institutions love beneficiary designations, as well as joint accounts, because it is so much easier for them. You are encouraged to name beneficiaries or joint owners because if something happens to you (i.e. you die), the account “will avoid probate”. You are given a false sense of security that you have done proper planning and that your beneficiary designations always will give what you have to whom you want, when you want and the way you want.
The exclusive use of beneficiary designations for your estate plan is no substitute for a properly drafted will or trust based estate plan. Without additional planning, there is no assurance that beneficiary designations will avoid the intrusion of the probate court. There can still be probate court activity in many situations.
I only recommend beneficiary designations as an exclusive estate planning tool if you can guarantee that none of your beneficiaries is a minor, gets divorced, gets sued, gets sick, or dies in the wrong order. And of course, you can’t. Beneficiary designations are not a substitute for a properly drafted estate plan which, at a minimum, includes financial and health care powers of attorney and a will, and often includes a revocable living trust. You can avoid these problems of beneficiary designations by having a properly drafted will or trust based estate plan, and coordinating beneficiary designations with that plan.
By: Matthew M. Wallace, CPA, JD
Published edited April 3rd, 2016 in The Times Herald newspaper, Port Huron, Michigan as: I am a Life Insurance or Account Beneficiary and the Owner Died – What Do I Do Now?