Are your life insurance beneficiary designations up to date?

Something a lot of people overlook when they update their estate plans are beneficiary designations on life insurance, retirement plans and annuities. Beneficiary designations are easy to overlook, because when most people think about estate planning, they think about wills, trusts, powers of attorney and healthcare proxies. But, for many people, much of their property passes at death outside of wills and trusts by virtue of contractual beneficiary designations.

If those designations are not up to date or have not been coordinated with provisions in the will and trust, there can be unwelcome surprises. This article focuses on beneficiary designations for what is often an individual's largest asset passing at death -- life insurance.

Under our legal system, property is transferred at death in one of four ways - via will, legal title, contract, or state intestacy laws. A properly drafted will transfers what are known as probate assets. These are assets owned at death and include solely owned stocks, real estate, and personal items. Property passing by title is usually real estate owned jointly with another person.

A good example is a home owned in joint tenancy with right of survivorship with your spouse. What a lot of people do not understand is that property owned in joint tenancy with right of survivorship is not considered probate property and does not pass under the will. The legal title overrides the will. Your spouse takes sole ownership of your home, even if your will says it's to go to Aunt Betsy.

Types of beneficiary designations

There are two types of life insurance beneficiary designations - primary and contingent. The primary beneficiary is the individual or entity designated to receive death benefits following the insured's death. The contingent beneficiary is the individual designated to receive the death proceeds, if the primary beneficiary is no longer alive.

Beneficiaries are first designated in the life insurance application. More often than not, a spouse is designated as primary beneficiary and a parent, sibling, or child is designated as contingent beneficiary. Initially, it often makes sense to designate the spouse as primary beneficiary, but it is important to re-evaluate that decision as circumstances change. If you and your spouse become separated or divorced, life insurance should be addressed in the separation agreement or divorce decree, especially where minor children are involved.

Although a spouse may have been comfortable managing the initial amount of death proceeds, you need to consider whether he or she remains comfortable receiving and managing a cash death benefit that may have doubled or tripled in amount since you purchased the policy. Receiving such a large sum of cash can be both a blessing and a burden.

A possible solution is to make a revocable living trust the policy beneficiary. The trustee, which can be an individual, bank, or trust company, will be responsible for investing and managing the death proceeds, not the surviving spouse.

Another potential trouble spot involves estate taxes. Although the federal estate tax is scheduled for repeal in 2010, the repeal is only for one year unless Congress makes it permanent before 2011. Many people are hoping for the best and planning for the worst. Assuming the estate tax remains with us, designating your spouse as primary beneficiary of your life insurance allows the proceeds to pass estate tax free at your death. However, the proceeds and/or any assets acquired with them are included in the surviving spouse's estate. That's unfortunate, because with a little planning the proceeds could have avoided estate taxation at both spouses death.

One solution is to have the life insurance owned by an irrevocable life insurance trust. The terms of the trust can provide for discretionary income and principal distributions to a surviving spouse, yes shelter the proceeds from estate taxation.

People often designate a parent or sibling as contingent beneficiary, when they do not yet have children. That may make sense at the time, but when a parent dies or a sibling marries someone you don't trust, it's time to revisit the designation. Chances are, you never envisioned the beneficiaries of your father's estate or a brother-in-law you never even liked receiving your life insurance, but it could happen unless you make a change.

Perhaps the most troubling situation arises when a spouse is designated as primary beneficiary and a minor child is contingent beneficiary. This may seem like the most natural way to go, but think it through. Often, the trigger for the payment of proceeds to little Johnny is a common disaster - and automobile accident, plane crash, or a terrorist event - resulting in the death of both you and your spouse.

The problem is that if Johnny is a minor - under the age of 18 in most states - he lacks the legal capacity to take receipt of the proceeds. Consequently, the probate court will appoint a guardian, who may or may not be the guardian designated in your will to receive and manage the proceeds. This can result in costly court fees and lengthy delays.

A better solution is to create what is sometimes referred to as a minor trust, which is nothing more than a revocable living trust, to serve as contingent beneficiary. The trust avoids delays and probate fees, can provide investment management expertise, and can be designed to work cooperatively with the guardian designated in your will to care for your minor child.

Conclusion

Getting the beneficiary designations on your life insurance right can be tricky. A licensed financial professional can help you make appropriate selections at the outset and can give you options regarding what steps to take should your circumstances change.

Sharon Stanley is a representative of The Prudential Insurance Co. of America in Cape Girardeau. (334-2603 )