When you think about estate planning, you probably imagine wills, healthcare documents, and maybe even trusts. While these are essential, they might not cover all your assets. If you’re not careful, your estate plan could leave out a significant portion of your wealth.
Why? Many assets are classified as “non-probate” assets, meaning they pass outside of your will. While this can speed up distribution and avoid probate costs, it can also cause problems if your beneficiary designations aren’t up-to-date. Here’s what you need to know about beneficiary designations and the common pitfalls to avoid.
What Are Non-Probate Assets?
Non-probate assets are distributed directly to the named beneficiaries when you pass away. These assets include life insurance policies and tax-deferred retirement accounts like 401(k)s or IRAs. For many New Yorkers, these assets make up the bulk of their net worth, as explained in our article, The Importance of Incorporating Life Insurance into Your Estate Plan.
If the beneficiary designations for these assets are outdated, a significant portion of your estate might not go where you intend. Below are some common mistakes related to beneficiary designations in New York City and how to avoid them.
1. Failing to Keep Your Beneficiary Designations Up-to-Date
Imagine you named your best friend as the beneficiary of your retirement account years ago. Fast forward ten years—you’re married with two kids and haven’t spoken to that friend in years. If you haven’t updated your beneficiary designation, your former friend will still inherit that money, even if your will now leaves everything to your spouse and children.
A federal court case described in the article “Court Backs 401(k) Beneficiary Designation in Estate Claim” from the National Association of Plan Advisors explains the importance of updating beneficiaries for retirement accounts. Despite the estate dispute, the court upheld the paper beneficiary designation of an old girlfriend who received the proceeds of a Proctor & Gamble employee’s retirement plan valued at $754,000. Ensuring that assets pass to the right person and to prevent an estate from being depleted by long, costly litigation is a strong example of why beneficiary designations need to be updated.
2. Not Removing Your Former Spouse or Partner
Outdated beneficiary designations can be especially problematic for divorced individuals. In most states, a former spouse is automatically removed from your will, powers of attorney, and healthcare proxies. This prevents your ex from making critical decisions, such as whether to continue life support.
However, this automatic removal doesn’t apply to retirement accounts. Even after a divorce, a former spouse remains the named beneficiary unless you update your designation. While some states have passed laws to address this, federal law currently overrides these provisions. Make sure to change the beneficiary on your retirement accounts if you’ve recently divorced.
Read our Steps for Updating Your Estate Plan After Divorce article or watch our popular videos on estate planning and divorce: Estate Planning for Divorced Parents and Estate Planning Issues in Divorce: Working With a Team to Protect Yourselves and Your Loved Ones.
3. Naming Your Children as Beneficiaries
It might seem logical to name your children as beneficiaries, but this can create legal and financial challenges in New York if they are under 18. Most insurance companies and retirement plan administrators will not release funds to minors, which means the court must appoint a guardian to manage the assets until your child reaches adulthood.
This process can be costly and time-consuming, with guardians required to submit annual reports to the court, creating a public record. These reports can expose your child’s assets to identity theft risks.
To avoid this, you can name a custodian to manage the assets until your child turns 18 or consider naming a trust as the beneficiary instead.
4. Naming Certain Trusts as the Beneficiaries of Retirement Accounts
While leaving assets in a trust for your children’s benefit is usually a good idea, naming a trust as the beneficiary of your retirement accounts can create tax issues. Retirement accounts are taxed differently than other assets, and transferring them to a trust could trigger significant income taxes for your beneficiaries.
If your children are under 18, consider naming a custodian for the retirement assets or leaving the account to a specialized trust designed to hold tax-deferred accounts. Working with an estate planning attorney and financial advisor can help ensure you’re making the right choices for your family.
5. Not Incorporating Beneficiary Designations Into a Comprehensive Estate Plan
Beneficiary designations aren’t something you should overlook. Even the most carefully crafted will or trust won’t help if your beneficiary designations are outdated or incorrect. To ensure your assets are distributed in accordance with your wishes, it’s important to review and update your designations as part of your broader estate plan.
Safeguard Your Future with a Qualified New York City Estate Planning Attorney
Beneficiary designations may seem like a minor detail, but they can have a major impact on your estate plan. Avoid these common pitfalls by regularly reviewing and updating your estate plan to ensure it reflects any life changes or new circumstances. Book an initial call with the estate planning team at The Village Law Firm. Our New York City estate attorneys will help you create a comprehensive plan that covers all your assets—both probate and non-probate.
