by Jonathan A. Nelson
Beneficiary designations and trusts are two common tools for probate avoidance.
Beneficiary designations are often used for their simplicity and cost-effectiveness. Life insurance policies, retirement plans, and payable-on-death bank accounts allow you to bypass probate and name a beneficiary directly. A death certificate and a few forms are usually all that are needed to transfer the asset after death. This streamlined process can provide relatively rapid financial resources, enabling the beneficiary to cover financial obligations with fewer delays and without court involvement. Setting up beneficiary designations is usually free or low-cost, especially compared to establishing and maintaining a trust. In addition, beneficiary designations may simplify any tax results, particularly for retirement accounts.
However, beneficiary designations also come with limitations. They offer little control over how or when assets are used after distribution, and can have adverse results if a minor or a beneficiary who is financially inexperienced or incapable is named.
Additionally, beneficiary designations require careful reading and maintenance. Life changes such as marriage, divorce, or the birth of children can make existing designations outdated, and failing to update the designations can result in the gifts going in unexpected directions. For instance, the federal Thrift Savings Plan recently changed its rules such that a widowed or unmarried retiree who designates her children as primary beneficiaries but survives one of them without updating her beneficiary designations will not benefit her grandchildren – even if they are named as backup beneficiaries. Each financial institution will have its own default rules on what happens if the designation cannot be followed exactly.
One of the most startling results can occur if the probate estate does not have enough assets to cover the decedent’s debts, expenses, and taxes. For bank accounts in Virginia, these beneficiary accounts may be clawed back into the estate with little or no warning, and the executor has significant discretion in selecting such accounts and pursuing the repayments. Not only can this result run contrary to the expectations of the beneficiary, it makes a beneficiary who saves their gift more easily collected from and a beneficiary who spends their gift potentially liable for the money already spent. The potential for beneficiaries to feel they are not being treated equally is significant, and litigation is probable over what each’s “fair share” is.
In contrast, trusts provide greater flexibility and control. While they are more complex and costlier to set up, trusts allow you to specify conditions for distributions, provide for contingencies, protect assets from creditors, and (this last point is probably more significant than most people think) leave a living, thinking person in charge of implementing the plan. This person has rights to seek changes if not all went as you anticipated, rather than a set of black and white instructions with no option for contingencies.
Beneficiary designations are still useful for many straightforward situations so long as they are understood and maintained, and a thoughtful combination of both beneficiary designations and trust provisions will often offer the most balanced and effective estate plan. Speaking to an estate planning attorney about these tools should include a discussion of your financial goals, family situation, and the desirability of control and contingency provisions.
Virginia attorney Jonathan A. Nelson practices in estate planning, probate, trust administration, business formation, and estate and trust litigation, and brings nearly 20 years of experience resolving conflicts, negotiating settlements, vigorously advocating in the courtroom, and navigating compliance matters. He uses a personal touch and extensive legal knowledge to ensure that the particular needs and interests of each client are reflected in the legal services they receive.
The attorneys of Smith Pugh & Nelson, PLC, offer the experienced counsel, personal attention, and customized legal services needed to address the many complex issues surrounding estate planning, probate, and trust administration. Contact us at (703) 777-6084 to schedule a consultation.