Beneficiary designations can be one of the most consequential, yet overlooked, pieces of a client's plan.
Brad Smith, founder of Capital Rock Wealth Management in Little Rock, Arkansas, should know: He said he had one case he'll "never forget."
As Smith recalled, a client had been gifted an annuity from his mother in 1987. The client was single at the time so named his sister as the beneficiary.
"He never disclosed that annuity to me," Smith said. "It sat outside the accounts I managed, and it never came up in our planning conversations."
Nearly four decades passed. The client married and built a life with his wife. Meanwhile, that beneficiary form was never updated. When the client died, Smith said he was tasked with sitting down with the widow and explaining that the annuity wasn't coming to her.
"It was going to his sister," Smith said. "She was, understandably, furious — at the situation, at her late husband and frankly at the entire system that allowed a piece of paper from 1987 to override everything they'd built together. There was nothing to do. The designation is a contract, and it controls."
A similar horror story played out before Nicholas St. George, founder of St. George Wealth Management in Stanley, North Carolina. He had just become an advisor at Merrill Lynch and was in the training program, shadowing advisors in the office and sitting in on some meetings.
The circumstances of one such meeting stuck with St. George: A husband and wife divorced. The husband stayed with Merrill Lynch, and his former wife moved to a new advisor. After a couple of years, the husband remarried and created a will with his new wife. He died shortly after. When the new wife came in to take over an individual retirement account, she found out that the former wife was still listed as its sole beneficiary.
"The ex-wife gets the IRA and the new wife gets a lesson about beneficiaries and transfer-on-death rules trumping any will and estate documents," he said.
Experts say proactive reviews and conversations are essential to diffusing such nightmare scenarios before they occur.
Preventing Confusion Ahead of Time
Advisors can address these scenarios by reviewing beneficiary designations regularly, especially after major life events such as marriage, divorce, remarriage, birth, death or any estate plan changes, said Adam Bergman, a tax and ERISA attorney and founder of IRA Financial, a self-directed retirement platform.
"A beneficiary review should be a standard part of every annual client meeting, not something handled once and forgotten," he said.
Cole Williams, founder of Vessel Financial Planning in Plano, Texas, said he asks clients to document beneficiary designations for every account, not just the ones he manages. He said he also requests copies of their estate plan documents so he can check for conflicts between the will and the account-level designations.
"These two things rarely match up on the first review," he said.
Many clients, Williams said, have never heard of "per stirpes," which means "by the branch." This allows assets to pass down through a deceased beneficiary's line to their heirs.
"If that's what a client wants, they must specifically elect it," he said. "It won't happen automatically. That's a five-minute conversation that can prevent significant problems much later."
The default on most accounts is "per capita," which means if a named beneficiary dies before the account holder, that share doesn't pass to that person's children, said Williams.
"It just disappears into the remaining beneficiaries' shares," he said.
When checking beneficiary designations, Samantha Mockford, associate wealth advisor at Citrine Capital in San Francisco, said that advisors need to make sure minor children are not named as direct beneficiaries because they cannot inherit assets.
"Their successor guardians would receive full control of the funds," she said. "Instead, parents need to fund a trust with specific language to care of their minor children, then name the trust as beneficiary."
If a client is charitably inclined, it can be tax-efficient to name a charity as a beneficiary on a pre-tax retirement account, said Mockford. That way, the funds are never taxed as they go in pre-tax, grow tax-free and are distributed to a tax-exempt 501(c)(3).
"This is much more tax-efficient than naming a charity as part of a taxable trust distribution at death," she said.
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