The use of individual beneficiary designations offers several advantages and disadvantages that should be carefully considered when engaging in estate planning.
One of the primary benefits of using beneficiary designations is the ability to bypass probate, allowing for a timelier transfer of assets upon the account owner’s death. Once upon a time, estate planning attorneys would instill fear in clients regarding probate fees and red tape, leading to the promotion of revocable living trusts which also avoid probate. While the living trust still reigns supreme for efficient estate planning, the reasons for such have changed dramatically over the past decades. With modern financial planning, the majority of a person’s estate passes outside of probate even without a revocable living trust. This is because virtually every financial asset an individual owns—ranging from annuities and brokerage accounts to checking and savings accounts and certificates of deposit—can be established with a payable-on-death or transferable-on-death beneficiary designation with the financial institution.
As an estate planning attorney, I often find myself recalling the words of my Wills & Trusts professor: “A contract always trumps a Will.” This means that if a person establishes a beneficiary designation on a financial account, which is essentially a contract between the owner and the institution to pay the balance to the beneficiary upon the owner’s death, the financial institution does not care what the account owner’s Will says. Consequently, probate is unnecessary to transfer the asset at the account owner’s death.
Avoiding probate results in lower costs and greater privacy. However, it should be noted that, although assets passing via beneficiary designation avoid probate per se, they are considered part of the probate estate for limited purposes in North Carolina. This means that while the personal representative of the probate estate does not have to collect and account for assets passing via beneficiary designation, they are still required to report the date-of-death values of most accounts with beneficiary designations on page two of the Inventory of Decedent’s Estate. While the identities of the beneficiaries are not reported, the personal representative typically must discover these identities in case the estate is insolvent and any accounts with beneficiary designations need to be recovered for the payment of debts. Therefore, while accounts with beneficiary designations are technically outside of the probate process in North Carolina, information regarding such accounts is not entirely free from public record or the scrutiny of the estate’s personal representative. Conversely, assets owned by a living trust are not reported at all on the court forms required for a probate estate.
Another advantage of beneficiary designations is that the owner retains the right to change the beneficiary at any time without the need to go through an attorney to change their Will. While I like to think my clients enjoy seeing me on occasion, this flexibility is often viewed as an advantage from the public’s perspective. Finally, beneficiary designations generally make the account harder for estate creditors to recover. Although assets that pass via beneficiary designation are subject to claims against the estate, if all assets pass outside of probate, the onus may end up on the creditor to open an estate. Additionally, from a practical standpoint, it can be challenging and costly for a personal representative of an estate to recover assets that pass via beneficiary designations. Probate assets and real property owned by the decedent generally must be exhausted first.
However, there are also notable drawbacks to using, or at least overusing, individual beneficiary designations. First, individual beneficiaries may predecease the owner, become incapacitated, or lose contact with the owner, complicating the transfer of assets after the owner’s death. If a beneficiary predeceases the owner, the asset will typically revert to the deceased account owner’s estate, requiring probate. Furthermore, some financial institutions may have their own internal policies regarding the distribution of an account if the beneficiary is deceased, which may conflict with the deceased owner’s wishes.
Additionally, the use of beneficiary designations can lead to confusion and disputes among heirs and make estate administration in general more difficult. Beneficiary designations can create challenges when they are inconsistent with the overall estate plan of the account owner. For example, if a person’s Will or living trust leaves everything to their three children, but most of the person’s assets are in a large brokerage account that designates only one child as the beneficiary, the other children may be confused about their parent’s intent, leading to potential litigation. Beneficiary designations can complicate estate administration in cases where debts or costs of administration need to be paid in a probate estate opened solely to clear title to the decedent’s home or car, but all cash assets have passed outside of probate directly to beneficiaries. In such cases, the Executor or Administrator of the estate must convince the designated beneficiaries of those accounts to contribute funds for estate administration. Moreover, if a person wishes to provide general gifts to individuals, such as “the sum of $10,000 to my grandchild Billy,” and includes such provisions in their Will, they often do not realize that if they have designated their children as beneficiaries of all their accounts, their Executor will not have access to those accounts necessary to fulfill the general devise to Billy. Therefore, the Executor may be unable to comply with the general bequest for Billy in the Will.
While beneficiary designations can simplify the transfer process, they do not provide the same level of control and protection as other estate planning tools, such as trusts. A trust cannot die; thus, when a trust is the owner or beneficiary of an account, it is assured to control the disposition of the account when the account owner passes away. If a trust is designated as the owner or beneficiary of all accounts, a simple amendment to the trust can address any necessary changes to the estate plan, rather than requiring updates to beneficiary designations across multiple financial institutions. Additionally, client’s often want equalization provisions, general bequests of cash, first rights of purchase for real estate, and other terms which are nearly impossible to implement and enforce without a trust where all assets will be collected before distribution of the estate. The successor trustee can collect all accounts and assets upon death, pay any costs of administration and general bequests, hold back shares for underage or incapacitated beneficiaries (or for other asset protection reasons), and then distribute the remaining shares according to the trust terms.
In conclusion, the advantages of overusing individual beneficiary designations are likely outweighed by the disadvantages, especially when more efficient alternatives, such as trusts, are available.