Beneficiary Designations in Estate Plans

Proper estate planning requires counsel to evaluate a client’s circumstances broadly and consider what best suits a client’s needs. An estate planning client’s needs can range from sophisticated tax planning to determining a simple mechanism for transferring a client’s assets at death. Many of the tools that high-net-worth clients use for planning are neither suitable nor necessary for a client of more modest means. However, beneficiary designations are a versatile estate planning tool that are used as part of both sophisticated estate plans for high-net-worth clients and simple estate plans for clients of more modest means.

Beneficiary designations are a simple way for a client to designate a beneficiary to receive certain types of assets when the client dies, without giving the beneficiary an ownership or beneficial interest in the asset during the client’s life. This article discusses how to use beneficiary designations, the advantages and disadvantages of using beneficiary designations, and some important considerations when using beneficiary designations in a client’s estate plan.

Beneficiary Designations

Clients cannot rely on a will or a trust alone to transfer all assets at death. The principles of contract law govern the transfer of some commonly owned assets and, on the owner’s death, those assets are transferred under the terms of the contract between the owner and the institution that holds and manages the asset.

The contract terms generally allow the owner to choose the beneficiaries of the asset, often by completing a beneficiary designation form provided by the institution. It is crucial to complete all beneficiary designations in the correct form. If the beneficiary designation form is incomplete or if the designated primary and contingent beneficiaries predecease the owner, the asset is generally distributed according to the default rules in the contract, regardless of any contrary provision in the owner’s estate planning documents.

A beneficiary designation:

• Transfers property outside of probate.
• Delays a beneficiary’s ownership and access to an asset until after the owner’s death.

Common assets that pass by beneficiary designation include:

• Life insurance policies.
• Retirement plans (such as 401(k) plans, individual retirement accounts (IRAs), and 403(b) plans).
• Annuities.
• Health savings accounts.
• Employee stock purchase plans.
• Deferred compensation plans.
• Stock options.

Primary and Contingent Beneficiaries

An owner may designate two types of beneficiaries to receive certain assets on the owner’s death:

• A primary beneficiary that is first in line to receive the asset.
• A contingent or secondary beneficiary that receives the asset if the primary beneficiary predeceases the owner or disclaims the asset.

A beneficiary can be either a person or an entity (such as a trust or charitable organization) and the owner may generally name multiple beneficiaries as primary and contingent beneficiaries. The owner may also designate the percentage of an asset that each beneficiary is to receive if the owner names multiple beneficiaries in the same category of beneficiary. For example, if the owner names two primary beneficiaries, the owner may specify that each primary beneficiary receives 50% of the asset on the owner’s death.

Default Beneficiaries

Most contracts that govern an asset that passes by beneficiary designation include a provision identifying a default beneficiary. The default beneficiary receives the asset if either:

• There is no designated beneficiary on file.
• All primary and contingent beneficiaries predecease the owner or disclaim their respective interests.

The default rules vary among institutions and sometimes among assets within the same institution. The default beneficiary is often the owner’s estate or certain family members of the owner, but this is not always the case and is not always a desirable result for the owner.

Counsel should not assume a particular structure or advise clients that any particular default beneficiary is applicable in all cases. Counsel should ask the client for a written copy of all account agreements and current beneficiary designations before providing any advice regarding beneficiary designations on an account or opining on the identity of the default beneficiary.

Clients wanting to pass all property to one primary beneficiary often resist naming contingent beneficiaries. It is especially important to identify the default beneficiary for the client in these circumstances. By identifying the default beneficiary, the client can make an informed decision about whether to either:

• Allow the default beneficiary to potentially inherit.
• Include a contingent beneficiary to make it less likely that the default beneficiary inherits.

Use of Beneficiary Designations in Estate Planning

Estate planning attorneys generally use beneficiary designations as one of a few simple methods to:

• Avoid probate. Assets that transfer by beneficiary designation are non-probate assets, unless the recipient beneficiary is the estate. Non-probate assets pass outside the will terms.
• Transfer assets to beneficiaries on a client’s death without the beneficiary having a current right to the asset during the client’s life.
• Create flexibility in estate plans. For example, one or more assets with beneficiary designations can allow a client to change gifts as part of an overall estate plan without changing other governing instruments.

Beneficiary designations are also an important element in estate planning for both large and small estates, particularly when individuals amass large amounts of assets in retirement plans and life insurance policies.

Clients often complete beneficiary designation forms without involving attorneys. It is important for counsel to:

• Inquire about all assets with beneficiary designations to help:
  • determine the client’s overall asset picture; and
  • ensure the beneficiary designations are consistent with the plan that counsel and the client create.
• Ask to see copies of the beneficiary designation for each asset with a beneficiary designation to:
  • make sure the forms are filled out properly; and
  • confirm the client’s understanding of the designated beneficiaries.

Many clients routinely name:

• A spouse or partner as a primary beneficiary.
• Children or the estate as the contingent beneficiary.

However, these routine designations may not accomplish the client’s estate planning goals. When preparing an estate plan for a client, counsel should review the client’s assets and current beneficiary designations. It may be necessary to work with the client’s financial advisor to determine current designations and discuss how those designations may affect the estate plan.

Beneficiary Designations in Basic Estates

A beneficiary designation is a simple option for transferring assets at death, particularly for a client:

• With a modest estate.
• With a few assets that the client wants to pass to designated beneficiaries.
• Without sufficient assets to warrant creating and funding a revocable trust.
• Who does not want the ultimate beneficiary of the client’s asset to have a current right to access the asset during the client’s life.

A client with a relatively modest estate, straightforward assets, and an uncomplicated intended beneficiary structure may use various forms of beneficiary designations as the client’s primary estate planning tool, along with other tools as needed, to transfer all or the bulk of a client’s assets outside of probate, including:

• Deeds that allow the client to retain the client’s ownership interest in and full control over their real estate during life and designate a beneficiary to receive the real property by operation of law at the client’s death. These deeds are authorized in most states and are commonly referred to as transfer on death deeds, but may have different names depending on the jurisdiction, such as enhanced life estate deeds or lady bird deeds.
• Accounts at financial institutions that allow the client to designate a beneficiary for the specific account but give the beneficiary no current rights to the account during the client’s life, such as pay on death (POD) accounts, transfer on death (TOD) accounts, and Totten trust accounts.
• Joint ownership of various types of property with a right of survivorship.

For example, assume a client has:

• A residence.
• An IRA.
• A brokerage account.
• A checking account.

If the client wants all assets to pass to one responsible adult, the client may transfer all assets outside of probate using:

• A transfer on death deed for the residence if the jurisdiction allows this type of deed.
• A beneficiary designation on the IRA.
• A TOD designation for the brokerage account.
• A POD designation for the checking account.

Even if a client intends to use beneficiary designations as the primary method to transfer assets, counsel should strongly recommend that the client also execute a will. A will covers the disposition of assets that fail to pass by beneficiary designation for any reason, including:

• Assets for which a beneficiary designation cannot be used, such as tangible personal property.
• Property that the client acquires after the estate plan is prepared and for which the client forgets to designate a beneficiary.
• Assets that are payable to the client after death, such as income tax refunds or other types of refunds.

Beneficiary Designations in Complex Estates

Clients with significant estates, varying asset classes, blended families, or wanting to include trusts for beneficiaries generally require more complicated estate plans. In these situations, beneficiary designations are typically only one piece of a more complex estate plan. However, counsel can still use beneficiary designations to transfer a significant portion of the client’s estate at death.

To create an effective estate plan, counsel must carefully review all of a client’s assets and determine how each asset passes at death. If not coordinated with the overall plan, property passing by beneficiary designation can interfere with and render ineffective both the dispositive provisions and tax planning strategies implemented in the client’s estate planning documents.

There are many factors that combine to determine when to use beneficiary designations in a complex estate plan and how beneficiary designations work with wills and trusts.

Effect of Beneficiary Designations on Complex Estate Plan

Assets with a beneficiary designation pass under the designation, not by the provisions in the client’s will or revocable trust instrument. Though this is often the desired result, there may be unintended consequences. Counsel should consider all relevant factors when preparing or considering beneficiary designations in a complex estate, including:

• The effect on the estate plan.
• Survivorship issues.
• Estate tax planning.
• Any retirement accounts involved.
• Tax apportionment.

Overall Effect on the Estate Plan

Counsel should review the effect that assets passing directly to designated beneficiaries have on the overall estate plan. For example, if the client wants to split the client’s assets equally among three children, but has a life insurance policy with only one child named as a beneficiary, counsel should include an equalizing provision in the will or revocable trust instrument to ensure equal treatment among the children.

Survivorship

A client’s estate plan generally addresses what happens when a named beneficiary predeceases the client and carefully crafted beneficiary designations can deal with some of the same contingency and survivorship issues. Counsel should discuss the various potential outcomes if a named beneficiary predeceases the client to ensure the beneficiary designation is drafted according to the client’s wishes. This often requires a custom beneficiary designation. The basic form provided by institutions may not be able to address certain contingencies, such as per stirpes designations (a per stirpes designation indicates if the named beneficiary predeceases the client, how that beneficiary’s share is distributed to that beneficiary’s living issue).

Some institutions may allow custom-drafted beneficiary designations, but others may not. Counsel should carefully review each institution’s form and rules for beneficiary designations, and prepare the designations accordingly.

Estate Tax Planning

Counsel must consider how a client’s property passes to determine whether an estate plan that includes significant assets passing by beneficiary designation is effective for federal and state estate tax deferral or minimization purposes. Tax structures created by a will or revocable trust instrument, such as the creation of a credit shelter or qualified terminable interest property trust, may be undermined if a significant portion of the estate assets pass under a beneficiary designation rather than under the will or trust instrument.

Planning with Retirement Accounts

With an estate of any size, clients should be mindful when naming beneficiaries on certain eligible retirement plans, such as 401(k) plans and IRAs, as defined in 26 U.S.C. § 402(c)(8)(B) and referred to generally in this Note as retirement accounts. Counsel should advise the client about the specific rules for age, distribution amounts, and penalties for early withdrawal that may affect the beneficiary selection for retirement accounts (26 U.S.C. §§ 408 to 409A).

Although historically a beneficiary of a retirement account may generally stretch the retirement account distributions during the beneficiary’s lifetime after the original account owner’s death (stretch treatment), with the passage of the SECURE Act, for clients dying on or after January 1, 2020, the beneficiary of the client’s retirement account is, in most circumstances, required to take all distributions from the retirement account within ten years of the client’s death (26 U.S.C. § 401(a)(9)(H)(i)). However, certain beneficiaries, referred to as eligible designated beneficiaries, remain eligible for stretch treatment (with some limitations). Eligible designated beneficiaries include:

• The client’s surviving spouse.
• The client’s minor children.
• Disabled individuals.
• Chronically ill individuals.
• A beneficiary not more than ten years younger than the client.

(26 U.S.C. § 401(a)(9)(E)(ii).)

Before the passage of the SECURE Act, when a client did not want a designated beneficiary to receive the client’s retirement account proceeds outright, attorneys commonly included conduit trusts in the client’s will or trust instrument because conduit trusts allowed the client to designate a trust as beneficiary while maintaining the ability to stretch retirement account distributions over the trust beneficiary’s lifetime. Under the SECURE Act, most beneficiaries are no longer able to stretch retirement account distributions over their lifetime in any circumstances. Counsel should review all clients’ estate plans to ensure that the current structures work as intended. In particular, counsel should revisit the estate plan of clients who have:

• Named beneficiaries who are not eligible designated beneficiaries on their retirement accounts.
• Incorporated conduit trusts into their estate plan. In some cases, particularly for conduit trusts drafted before passage of the SECURE Act, the provisions of the conduit trust are likely to inadvertently require that the entire balance of a retirement account be paid out to the beneficiary outright, all at once, and earlier than anticipated.

Tax Apportionment

Counsel should carefully consider which assets should bear the burden of estate taxes, if any, particularly in an estate with assets passing outside of probate. The provisions in a will or trust instrument that provide for how estate taxes are apportioned among the beneficiaries and the assets that pass on the client’s death generally control. Without evidence of the client’s clear intentions, detailed and often complex state and federal apportionment rules apply instead (26 U.S.C. §§ 2206, 2207, 2207A, and 2207B, for example, § 733.817, Fla. Stat., Cal. Prob. Code § 20110, N.Y. EPTL § 2-1.8, 20 Pa. C.S.A. § 3702, and Tex. Est. Code Ann. §§ 124.001 to 124.018).

If a client uses a will or revocable trust instrument and beneficiary designations, counsel should:

• Review the provisions of the will or trust instrument in relation to apportionment of estate expenses and estate taxes.
• Discuss with the client the effect of the provisions on the beneficiaries.
• Consult tax apportionment statutes and include appropriate tax apportionment provisions in the will or trust instrument to ensure that the taxes are paid from the desired assets.

Advantages of Beneficiary Designations

The advantages of using beneficiary designations to transfer assets include that:

• The concept is straightforward and easy for the client to understand.
• Completing beneficiary designation forms is inexpensive for the client.
• The client can change beneficiaries at any time, often without counsel’s help.
• The client may name multiple beneficiaries and specify different distribution percentages for each beneficiary.
• The client may name different types of beneficiaries, such as:
  • a trust for the benefit of a minor beneficiary or a beneficiary with a disability;
  • the client’s own estate; or
  • a charity.
• Assets can pass outside of probate, saving time and money.
• Beneficiaries receive assets relatively quickly. The named beneficiary generally receives the asset shortly after completion and presentation of a claim form and proof of identification and death.

Disadvantages of Beneficiary Designations

The disadvantages of using beneficiary designations to transfer assets include that:

• Beneficiary designation forms often limit the client’s options to relatively simple designations and distributions.
• Payouts are made outright to the beneficiary, regardless of the beneficiary’s ability to manage money, with limited exceptions for designations naming a custodian or trustee.
• If a beneficiary designation is used to pass the asset to the beneficiary outright, rather than in trust, the asset may be exposed to a beneficiary’s creditor claims once distributed. Depending on state law, holding assets in trust longer term may provide spendthrift protection for any assets that remain in trust (for example, § 736.0502, Fla. Stat. and Tex. Prop. Code Ann. § 112.035).
• Assets with a designated beneficiary that are includible in the client’s gross estate for estate tax purposes may subject the estate to estate and generation-skipping transfer tax liability, requiring attention to tax apportionment issues that should be addressed by a will or revocable trust provision.
• Financial institutions may require that the client obtain the Social Security numbers of designated beneficiaries, which sometimes means the client must approach a beneficiary about the designation before death. This may decrease the client’s ability to keep plan details private.
• Beneficiary designation forms generally lack safeguards (such as a witness requirement) to protect against undue influence or lack of capacity.
• Clients with many small accounts (such as CDs or POD accounts) may have a hard time keeping track of all their accounts each time they want to change beneficiaries.

Special Considerations for Beneficiary Designations

Counsel should advise the client on the potential issues that can arise with the use of beneficiary designations, such as those involving:

• The death of a beneficiary.
• Distribution to a minor beneficiary.
• Distribution to a beneficiary with a disability.
• Divorce.

Death of Beneficiaries

If the primary beneficiary predeceases the account owner, the assets pass to the contingent beneficiary, if the account owner named one. If the contingent beneficiary or beneficiaries all also predecease the account owner, the assets pass to the default beneficiaries under the terms of the governing documents of the financial institution that holds the asset. The default beneficiary is often the account owner’s estate. If this is the case:

• A probate is likely necessary.
• Depending on the type of asset, this may have undesirable tax effects.

Counsel should advise clients to update beneficiary designations any time a primary or contingent beneficiary dies. If the primary beneficiary dies during the client’s life, the client can name the contingent beneficiary as the primary beneficiary and name a new contingent beneficiary or can make any other desired changes.

Minor Beneficiaries

Naming a minor as a contingent beneficiary is common. For example, married couples with children frequently name each other as primary beneficiary and their children as contingent beneficiary. However, naming a minor as a beneficiary (even a contingent beneficiary) should be a last resort, because:

• Estate representatives, financial institutions, life insurance companies, or plan administrators generally cannot distribute assets directly to a minor.
• Clients generally do not want a minor child to inherit assets outright and even clients naming a minor child as primary or contingent beneficiary do so under the assumption that by the time the child inherits the asset, the child is no longer a minor.

Counsel should advise clients of the various options that exist to avoid including a minor as an outright beneficiary. These options sometimes depend on the value of the asset being distributed and typically include distribution to:

• The minor’s parent directly.
• A custodian under the Uniform Transfers to Minors Act (UTMA).
• A trustee of a trust for the minor’s benefit.
• A court-appointed guardian.

Distribution to Parent

In some states, if the total amount transferred is less than a certain amount, either of the minor’s parents, as the child’s natural guardian, may receive the assets on behalf of the minor (for example, § 744.301(2), Fla. Stat., N.Y. SCPA § 2220(1), and Tex. Prop. Code Ann. §§ 141.006 to 141.008).

Distribution to UTMA Custodian

Instead of naming a minor as a beneficiary, the client can name an adult as a custodian for the benefit of the child under a state Uniform Transfers to Minors Act (UTMA). Every US state has adopted some form of UTMA that includes a provision allowing for naming a custodian (for example, §§ 710.101 to 710.126, Fla. Stat., 760 ILCS 20/1 to 20/24, and M.G.L. c. 201A, §§ 1-24). Naming a custodian avoids the time and expense of appointing a guardian for the minor if the minor becomes entitled to the assets. When assets are held in a custodianship, the minor receives the assets outright at a certain age, depending on how the initial transfer was made. For example, under UTMA, the minor receives the assets at age:

• 21 if the transfer was made by gift, exercise of power of appointment, or transfer authorized by will or trust instrument.
• 18 if the transfer was made by a fiduciary or obligor.

(UTMA § 20, for example, § 710.123(1), Fla. Stat., 20 Pa. C.S.A. §§ 5320 and 5321, and Tex. Prop. Code Ann. § 141.021.)

State law may also include the option for the custodian to delay the final distribution under certain circumstances. For example, some states allow for a delayed distribution to age 25 if permitted in the language creating the custodianship (for example, Cal. Prob. Code §§ 3920 and 3920.5; § 710.123(1), Fla. Stat.; 20 Pa. C.S.A. §§ 5320 and 5321).

The custodian typically may use the funds on the minor’s behalf or pay funds to the minor as the custodian deems advisable until the minor reaches the age for outright distribution (for example, UTMA § 14(a), § 710.116(1), Fla. Stat., and M.G.L. c. 201A, § 14(a)).

Even if a client does not name a custodian for a minor, assets can still be transferred to an UTMA custodian instead of outright to the minor in certain circumstances, including:

• If the assets pass under a will or trust instrument or by intestacy, in which case a personal representative or trustee can transfer the assets to an adult or trust company as custodian for the minor under an UTMA account if:
  • that fiduciary considers the transfer to be in the best interests of the minor;
  • the transfer is not prohibited by or inconsistent with provisions of the applicable will, trust agreement, or other governing instrument; and
  • a court authorizes the transfer, if the transfer exceeds a certain value.

(UTMA § 6, and for example, § 710.107, Fla. Stat.)

• If the assets do not pass under a will or trust instrument or by intestacy and:
  • a custodian is named to receive the asset, in which case the obligor may transfer the asset to the UTMA custodian for the minor; or
  • no custodian has been nominated or all persons nominated custodian die or cannot serve, in which case the obligor may transfer the asset to an adult member of the minor’s family or to a trust company as UTMA custodian unless the property exceeds a certain value.

(UTMA § 7, and for example, § 710.108, Fla. Stat.)

Distribution to Trust

If the client’s estate plan includes a trust for the benefit of a child, the client can name that trust as beneficiary instead of naming a custodian. The beneficiary designation may indicate that the trust is the beneficiary of the asset directly or, if the client wants the trust to be beneficiary only if the child is under a certain age when the beneficiary designation becomes operative, the beneficiary designation can provide that the child is the beneficiary and indicate that if the child becomes entitled to the asset at a time when the child is under the desired age, the asset is instead distributed to the trust and then held and distributed under the terms of the trust.

Distribution to Guardian or Conservator

If the beneficiary designation does not name a custodian and instead lists the child alone as beneficiary, a guardian or conservator may need to be appointed to oversee the assets. Some states use the term conservator and conservatorship interchangeably with the terms guardian and guardianship, while other states, like Georgia, bifurcate the duties or responsibilities of a guardian and conservator (O.C.G.A. §§ 29-1- to 29-5-140).

Counsel should consult local law for the appropriate terminology and roles applicable to guardianships and conservatorships, which can vary widely. However, a guardianship or conservatorship over a minor typically ends when the child turns 18 and the child then receives any remaining assets outright (for example, §§ 744.102(13) and 744.521, Fla. Stat., O.C.G.A. §§ 29-3-64 and 29-3-71, and 20 Pa. C.S.A. §§ 5111 to 5116). Guardianship and conservatorship proceedings are often time-consuming and expensive and many clients want to avoid them. Therefore, naming a minor as beneficiary in a beneficiary designation is generally not advisable.

Beneficiary with Disabilities

A distribution to a beneficiary with a disability may jeopardize the beneficiary’s eligibility for certain government assistance programs. If the client wants to name a beneficiary who is incapacitated or has a disability and is currently receiving or is expected to receive means-tested government benefits, counsel should recommend the use of a special needs trust. The client names the trust as beneficiary of the asset and the trustee of the trust administers the funds for the benefit of the beneficiary.

Marriage and Divorce

The rules for beneficiary designations on marriage and divorce differ depending on state law and on the type of asset as well as any marital or divorce agreements in existence or statutes that control the disposition of the given asset.

In some states, divorce has an automatic revocatory effect on dispositions to a former spouse by will or trust instrument, but has no effect on beneficiary designations (for example, see Kruse v. Todd, 389 S.E.2d 488 (Ga. 1990), Richard v. Martindale, 2010 WL 2365024, ¶2 (N.D. Ill. 2010), and Stiles v. Stiles, 487 N.E.2d 874, 875 (Mass. App. Ct. 1986)). However, in other states, beneficiary designations made by a client in favor of a spouse typically become void on divorce or annulment and the client’s interest in the asset passes as if the client’s former spouse predeceased the client (for example, § 732.703(2), Fla. Stat., N.Y. EPTL § 5-1.4, 20 Pa. C.S.A. § 6111.2, and Tex. Est. Code Ann. § 123.053).

Counsel should consult state law when creating beneficiary designations to ensure that the client understands what happens to beneficiary designations in favor of a former spouse if the client does not change the beneficiary designation before death and make changes to the beneficiary designations accordingly, if necessary.

Spouse as Beneficiary of Qualified Retirement Plans Under ERISA

State laws regulating the administration of qualified retirement plans in relation to marriage and divorce may be preempted by the Employee Retirement Income Security Act (ERISA) (29 U.S.C. §§ 1001 to 1191d). ERISA governs employee sponsored 401(k) plans, but not IRAs (29 U.S.C. § 1051(6)). Under ERISA, an individual may not designate a beneficiary other than the individual’s spouse, unless the spouse affirmatively waives the spouse’s right to the account in writing (29 U.S.C. § 1055(c)(2)(A)).

Where an owner is divorced but never updates the owner’s beneficiary designation to remove the former spouse, ERISA requires the plan to follow the decedent’s beneficiary designation on the decedent’s death and distribute the benefits to the former spouse, even if the former spouse waived the former spouse’s right to the account in a divorce agreement (see Kennedy v. Plan Adm’r for DuPont Sav. & Inv. Plan, 555 U.S. 285, 299-300 (2009)).

Courts in several jurisdictions have held that a distribution to the former spouse in this circumstance does not necessarily mean that the former spouse can retain the proceeds after distribution. It is possible that another party can assert a claim to the proceeds on other grounds after distribution. (See, for example, Metlife Life & Annuity Co. of Connecticut v. Akpele, 886 F.3d 998, 1007 (11th Cir. 2018), Estate of Kensigner v. URL Pharma, Inc., 674 F.3d 131, 135-137 (3d Cir. 2012).)

To avoid an unintended payout of benefits to a former spouse and a potentially expensive legal battle, a divorcing owner should affirmatively change the beneficiary designation and obtain a qualified domestic relations order (QDRO) as part of the divorce proceeding. The terms of the QDRO supersede ERISA provisions (29 U.S.C. § 1056(d)(3)).

Trusts as Beneficiaries of Life Insurance Proceeds

For clients with sufficient assets, where the assets, including the payout value of an insurance policy, are significant enough to implicate estate tax consequences, an irrevocable life insurance trust (ILIT) is a common estate planning tool. A properly drafted, funded, and administered ILIT can:

• Shield potentially substantial life insurance proceeds from estate tax in the insured client’s estate.
• Provide liquidity to an otherwise illiquid estate.

An ILIT is funded with one or more life insurance policies on the life of the client. The ILIT is generally funded by the insured client either:

• Transferring an existing life insurance policy on the client’s life to the ILIT.
• Creating the ILIT and the trustee then purchasing an insurance policy on the life of the client in the name of the trust.

For an ILIT to function as intended and remove the life insurance proceeds from the insured client’s estate, the trust must be the life insurance policy’s:

• Owner.
• Beneficiary.

Once the insured client dies, the trustee of the ILIT collects the policy proceeds and distributes them according to the ILIT’s terms. Beneficiary designations for life insurance policies that are intended to be held in an ILIT must be prepared correctly. If the insured client or the client’s estate is inadvertently named as beneficiary, the substantial estate tax benefits of the ILIT are compromised.

Communicating with Clients About Beneficiary Designations

A comprehensive estate plan generally includes beneficiary designations along with other estate planning devices, such as wills and trusts. Counsel should always discuss the client’s current beneficiary designations, determine whether the designations conform to the estate plan, and document a plan of how the client should change beneficiary designations, if necessary.

When an estate plan requires a change in beneficiary designations, counsel should address with the client how involved counsel is to be in effecting the beneficiary change and document the plan in a letter to the client. If the client is responsible for completing the changes without counsel’s assistance, counsel should include instructions in a letter to the client.

Updating Designations: Follow-Up with the Client

If a client has a trusted financial advisor overseeing most assets, this advisor often takes on most of the work in changing the client’s beneficiary designations. Sometimes, counsel may provide detailed assistance with updating beneficiary designations, but often counsel only provide instruction. Counsel should be clear about how much assistance is expected early in the planning process and confirm these details in writing.

Clients are sometimes reluctant to gather their current beneficiary designation information that counsel must review before recommending any changes. Counsel should always stress the importance of updating beneficiary designations as an integral part of an overall estate plan.

Counsel ideally should obtain written confirmation of all changes or a copy of the new beneficiary designations before closing a client’s file. This is sometimes not possible, but counsel should give the client sufficient written reminders and attempt to confirm changes whenever possible. If a client file is closed without confirmation of changes, the closing letter should:

• Emphasize the need to make changes to the beneficiary designations.
• Request that the client send in confirmation of any changes the client makes.

Drafting Considerations for Preparing Beneficiary Designations

When drafting beneficiary designations that name a trust under the client’s will or revocable trust instrument as a beneficiary, counsel must balance the need for specificity with the desire to avoid changes to beneficiary designations each time the client changes the client’s will or revocable trust instrument. Some factors to consider are that:

• General references to “my Last Will and Testament” as opposed to “my Last Will and Testament dated [DATE]” may be desirable. This minimizes the need to change beneficiary designations each time a will is updated. However, counsel must still review beneficiary designations each time a codicil or new will is prepared to ensure that any changes made to the will do not invalidate, inadvertently change, or confuse the identity of the designated beneficiary.
• References to specific provisions in a will or trust instrument should be specific enough that the reference can be clearly identified, but general enough to avoid a need to change the beneficiary designation each time a will or trust instrument is amended. For example:
  • a reference to a trust by name, such as to the “Trust for Children under my will” may be preferable to a reference to “the trust for my children under Paragraph B of Article X of my will” so that changes to the organization of the will can be made without affecting the designation; and
  • the name of the trust must be consistent in the will or trust instrument under which it is created and in the beneficiary designation naming that trust as beneficiary. When preparing a codicil or trust amendment, counsel should avoid changing the name of any trust that is also a beneficiary named in a beneficiary designation.

Financial institutions also may have certain requirements for:

• How specific a designation must be.
• What information must be included, particularly when:
  • naming a lifetime or testamentary trust; or
  • a custom designation is desired.

Counsel should contact the institution, explain the desired beneficiary designation, and involve the institution in the drafting process. Otherwise, the beneficiary designation that is submitted may be rejected and have to be re-done, which is likely to cost the client more in fees and time than would have been necessary if the institution was involved from the outset.