When Your Plan Doesn’t Work Out

Understand asset ownership and beneficiary designations in estate planning to avoid unintended consequences.

“Sarah” had a Will that left $50,000 specific bequest of cash to each of her five grandchildren, while the rest, including her residence, was to be distributed among her two daughters. At her passing she owned her Florida homestead, a $90,000 investment account, a $10,000 checking account and an IRA account of $1.2 million. Her two daughters were also the IRA account beneficiaries.  

So what happens at Sarah’s death? Does each of her grandchildren receive $50,000? The short answer to that question is “No.” 

The reason rests in the types of assets Sarah had at the time of her death. Her homestead is not an inventory asset of her probate estate under Florida law. Moreover, in my example it is specifically devised to her two daughters. That only leaves $100,000 of cash and other assets subject to her estate administration. This is what her will governs. 

What of the $1.2 million IRA account? That account has a beneficiary designation, so it is not subject to distribution under the terms of Sarah’s will. This leaves her $90,000 investment account and a $10,000 checking account. Assuming, for a moment, that there are no creditors, taxes or administration expenses associated with Sarah’s estate, then this $100,000 would be apportioned among the five grandchildren, with each receiving $20,000 as opposed to the $50,000 promised under the will. 

The grandchildren receive nothing from the IRA account because they are not a beneficiary of that account. Nor do they receive any equity from the homestead that was specifically devised to Sarah’s daughters. 

As you can see, it is therefore important to understand what assets you own and how you own them when making out your will or considering the distributions in your revocable living trust.  

The same problem as Sarah’s may arise when you have “Pay on Death” or “Transfer on Death” accounts. Assume that Sarah titled her investment and checking accounts as “Pay on Death” to her daughter, Jane. Even if Jane is named in Sarah’s will as her personal representative (executor), the pay on death designation would usually result in Jane inheriting the accounts. Jane would not distribute those accounts in her role as personal representative under the will. It doesn’t matter what Sarah has in the will, as her account would pass outside of the will. In this example, the grandchildren would inherit nothing. Jane’s sister would also not receive any interest in the accounts, even though she was to share equally with Jane under the terms of the will.  

Sometimes clients aren’t certain how life insurance and annuities work either. Most life insurance and annuity contracts have designated beneficiaries and therefore pass outside of a will or revocable trust. Sometimes the trust is named as the beneficiary. Since life insurance is generally income tax free, naming a revocable trust usually doesn’t carry any adverse income tax consequences. Annuities are a different story, however. 

Distributions from annuities usually carry with them some amount of ordinary income, resulting in the payment of income tax. The annuity contract should be carefully examined as well. If a person is not named as the contingent annuitant, then there is the possibility that the annuity company will make a full distribution upon the original annuitant’s death. This could result in a significant distribution that triggers a large income tax. If the trust traps the income inside, then the highest marginal tax rate may also apply, exacerbating the problem. 

This all highlights why you should have your estate planning attorney involved not only in the creation of your will and trust, but also in the proper titling of your various bank, investment and brokerage accounts, as well as having him at least confirm the proper beneficiaries of your IRA, 401(k), life insurance and annuities. Too often clients will take the advice of their financial planner – or worse – the bank teller – when deciding how to title their accounts. As you can see from this simple discussion, a coordinated, thoughtful review by a qualified professional could head-off unintended consequences. 

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