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Smart advisers don’t rely on a client’s memory about beneficiary designations; they ask to see paperwork, and not just on retirement accounts.
People name beneficiaries on their non-retirement securities and bank accounts, called transfer on death accounts, and often with very unhappy consequences for their heirs.
Beneficiary designations override the instructions in a will. As a result, they can instantly undo a carefully crafted estate plan, said Andrea Wasser, associate counsel at The Vanguard Group Inc. of Malvern, Pa.
“For affluent clients in particular, the consequences of putting a beneficiary on a non-retirement account can be significant,” she said.
TOD accounts automatically go to the named individual, avoiding probate. That’s a big selling point with clients, who often think probate is invariably expensive and time-consuming, when in fact cost and speed vary dramatically from state to state.
But Ms. Wasser said that advisers should protect their clients — and themselves — by making sure a TOD account doesn’t create more problems than it solves.
For example, removing an asset from the probate estate often has unintended consequences by not leaving enough liquid assets in the estate to fund trusts set up in the client’s will and pay outstanding medical bills, funeral expenses and taxes.
Estate plans frequently assume that non-retirement accounts will be available to fund a credit shelter trust or a trust for a child’s benefit, explained John Barnosky, an estate lawyer at Farrell Fritz PC in Uniondale, N.Y. If those accounts instead go to beneficiaries, leaving no assets available to fund the credit shelter trust, the heirs may forfeit a $2 million estate tax exclusion, he said. And if there are insufficient assets to fund a special-needs trust, a disabled child or grandchild may be left financially unprotected, Mr. Barnosky added.
According to Ms. Wasser, people often intend to use their retail-securities accounts to pay medical bills and funeral expenses, not realizing that the money will go to named beneficiaries rather than to the estate. She recalled one case in which an executor asked Vanguard if it could pay a portion of one such account to the estate to cover the decedent’s funeral expenses. “The answer [was] no,” Ms. Wasser said. “A beneficiary designation is part of a contract with a deceased shareholder. Only a court’s intervention can change it.”
People sometimes mistakenly think that they’ve reduced their estate tax liability by removing an account from their probate estate. The client’s taxable estate includes both probate and non-probate assets. “We’ve had a number of instances when tax authorities called us to locate account beneficiaries and collect unpaid taxes,” Ms. Wasser said.
Some family members may be unintentionally disinherited and seek restitution in court.
As an estate planner, Mr. Barnosky sees frequent mistakes involving TOD accounts. “People have designated one child as an account beneficiary, and they tell me they want to divide that same account equally among all of their kids in their will,” he said. “When I tell them the entire account will go to the named beneficiary, they say, ‘That’s not what I intended.’”
Such problems are easily fixed prior to a client’s death, of course. But if they’re discovered after a death, it’s a different story.
“Surviving family members will go to court, contending that Mama didn’t understand what she was doing,” Mr. Barnosky said.
Ms. Wasser agrees. She said cases where TOD accounts named a former husband or wife can be resolved fairly expeditiously if there was a divorce settlement in which the ex-spouse waived all rights to the decedent’s accounts. But other situations are thornier.
“I’ve seen cases where the decedent’s kids got the house, the bills and the taxes, and the decedent’s boyfriend or girlfriend got the TOD account,” Ms. Wasser said.
“Those cases often go to court. No matter how they’re ultimately decided, that is painful and expensive.”
Lynn Brenner is a weekly columnist on personal finance for Newsday, and has been a business journalist for over 25 years.
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