2015-08-04 | FinancialPlanning.com

Avoid These Beneficiary Blunders

Blog

Clients should have a will, but estate planning shouldn't stop there. Many assets pass to designated beneficiaries, so a periodic review of those selections can be crucial. A faulty designation can tarnish a decedent's legacy.

"Changing and reviewing beneficiaries are key steps in the estate planning process," says Ben Hockema, senior financial planner in the Park Ridge, Ill., office of Deerfield Financial Advisors.

Such a review might spot a minor child named as a beneficiary. "Technically, a child can't inherit an account outright, so he or she will need a guardian to act as caretaker of the assets until the child reaches the age of majority," says Gil Armour, a financial advisor with SagePoint Financial in San Diego. Depending on state law, that age generally ranges from 18 to 21.

TRUST, BUT VERIFY

According to Armour, the most common problem he sees in beneficiary designation occurs when clients get divorced. "They may forget to change the beneficiary of a 401(k) or an IRA," he says. "I try to remind them to do that when I learn of the divorce."

Hockema tells the story of a client of another advisor at his firm. "In our normal review process," he relates, "a new client was verbally giving us the beneficiaries for his 401(k), IRAs, and life insurance. This client was divorced and then remarried. He was adamant that his current spouse was named as the beneficiary of his $1 million life insurance policy."

However, this client did not have any documentation to verify making the change after his divorce. "After pushing the client to contact the insurance company," says Hockema, "it was confirmed that he had never changed the beneficiary from his first wife. Obviously, this was a major mistake avoided."

ADVERSE VERDICTS

Several court decisions testify to the importance of naming proper beneficiaries. The most important (Kennedy v. Plan Administrator for DuPont Savings & Investment Plan) came from the U.S. Supreme Court in 2009. William Kennedy, a longtime DuPont employee, had divorced his wife but never changed his beneficiary designation on the company retirement plan. Subsequently, Kennedy died and DuPont paid the balance of his account -- about $400,000 -- to his ex-wife. The estate sued but the Supreme Court unanimously ruled the error couldn't be corrected.      

Later decisions along those lines include Andochick v. Byrd, which resulted from the death of Erika Byrd. Again, Erika died while her ex-husband was still named as beneficiary of her 401(k) account. In 2013, the U.S. Court of Appeals for the Fourth Circuit ruled in favor of the ex-husband. This court said that Erika's parents, the administrators of the estate, could sue to recover the money, but that left the parents facing the expense and uncertain outcome of a lawsuit.

Beyond retirement plans, the U.S. Supreme Court came to a similar decision in Hillman v. Maretta, which involved life insurance. This 2013 verdict favored Warren Hillman's ex-wife, still named as beneficiary of a $125,000 policy, over Hillman's widow. Ironically, the Hillmans lived in Virginia, which has a state law designed to avoid such results. However, Hillman had been a federal employee, insured under a federal program, and federal law preempted Virginia law here.

The bottom line: for assets passing to a designated beneficiary, periodic updates can avert future troubles.

Donald Jay Korn is a Financial Planning contributing writer in New York. He also writes regularly for On Wall Street.

This story is part of a 30-day series on estate planning strategies.