Articles Posted in Beneficiary Designations

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A new development in probate law involves the use of transfer on death deeds for real property located in California. Other states have authorized the use of such deeds but it has only been available in California since January 1, 2016. Essentially, the deed works like any other transfer on death designation. When you die, your designated beneficiary inherits your house. The process sounds great in theory. Such a deed would completely circumvent a probate process. However, the use of such deeds should be done with extreme care and caution.

First, the transfer on death deed must be drafted in substantially the form outlined in the Probate Code Section 5642. The deed must be notarized and the beneficiary, or beneficiaries, must be specifically named. You cannot state, “to my children” or “to my siblings.” Such language is invalid and the transfer on death deed would fail.

Second, the person executing the deed must have “contractual capacity.” This is different than “testamentary capacity” and is a higher standard. Preparing a will requires only testamentary capacity. Testamentary capacity means that you understand that you’re signing a will, you understand who your natural heirs are, and you have an understanding of the types of property you own. Contractual capacity is a higher standard and requires that a person understand fully and completely whatever they are contracting to do.

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A surprising number of families learn the painful lesson that divorce doesn’t fully resolve beneficial ownership issues with certain retirement accounts. Any plans governed under the Employee Retirement Income Security Act of 1974 (ERISA) must follow specific rules and provisions, which will override the provisions in a marital settlement agreement. The only exception to this rule is if the couple has a Qualified Domestic Relations Order (QDRO) as part of the divorce settlement. The effect of all this is that if you designate your spouse as a beneficiary under an ERISA plan, and neglect to change that beneficiary designation after divorce, the now ex-spouse will receive the asset at your death.

Many states, California included, have enacted laws that prevent an ex-spouse from inheriting from the estate of a prior spouse. California Probate Code § 5600 states that if an individual designates a spouse as a beneficiary on an account, that spouse will not inherit the asset if the spouse is divorced at the time the individual dies. This makes sense. In general, most people wouldn’t want to leave any assets to an ex-spouse at their death. This code section was enacted to cure the simple mistake of not updating beneficiary designations after divorce.

Unfortunately, accounts governed by ERISA don’t follow state laws and thus the protection provided in the Probate Code doesn’t apply. The US Supreme Court has consistently ruled that beneficiaries listed on ERISA plans will receive the asset even if the beneficiary is an ex-spouse. This is true even if the couple has been divorced for decades. The only exception is a QDRO. Many do-it-yourself divorces don’t include a QDRO because the parties may not know what it is or may not know that it is required for their assets. According to the IRS, a QDRO must contain specific information regarding the retirement plan including the nomination of an alternate beneficiary, with his or her last known mailing address, and the amount or percentage to be paid to the alternate beneficiary. A simple marital settlement agreement will not be deemed a QDRO absent the required language.

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As Palm Desert estate planning attorneys, we frequently see clients with beneficiary designation issues. A recent article in the Wall Street Journal highlights this integral part of estate planning. A Will or Trust is very important but will not work for assets with beneficiary designations. Every year you should check your beneficiary designations to confirm they are valid and accurate.

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There are some common estate planning mistakes that our Palm Desert estate attorneys frequently see in our practice. Avoid these mistakes to ensure your estate plan is valid and accurately reflects your wishes.

Beneficiary Designations

Check your beneficiary designations on life insurance and retirement accounts. These assets generally pass outside of a living trust through a beneficiary designation. However, if you neglect to designate a beneficiary court action may be required to transfer these assets.

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A Trust is a written document that directs where your assets go when you die. However, unlike a will, a trust is a private instrument that does not require court intervention. If you have a trust you will avoid the court directed probate process and your estate can be administered privately and promptly.

Traditionally, trusts are used as probate avoidance techniques. However, Trusts are also beneficial for individuals wanting to have more control in the distribution of assets. Assets are distributed outright when they are distributed through probate, beneficiary designation or pay-on-death. A trust can instead provide that assets remain in trust until a beneficiary reaches a certain age, accomplishes some goal or indefinitely.

Trusts are especially helpful, yet overlooked, in the case of parents with young children. Many parents with minor children may still be establishing a career and may not be as financially secure as other adults. They may believe they do not have assets that warrant establishing a trust. However, they usually have substantial life insurance policies. Naively, the beneficiary designations on these policies generally lists the spouse first and then the children. The problem with this beneficiary designation is what happens when both parents die while the children are still minors? In this scenario, the life insurance policy will retain the proceeds until the children reach the age of 18. During the child’s minority, his or her guardian will not have access to these funds to care for the child. Additionally, the child will get the entire proceeds of the policy upon his or her 18th birthday. To avoid designating your minor children as the life insurance beneficiary, you can name your trust as the beneficiary after your spouse. This allows the trust provisions to designate when, where and how the proceeds are distributed.

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Retirement accounts and most other beneficiary designated accounts are traditionally left out of estate planning documents. A trust attorney will usually recommend that clients keep their IRAs and life insurance polices outside of a trust. However, there is a huge caveat to this advice, you MUST have the appropriate beneficiaries designated.

For parents with minor children, the issue of who to designate is usually incorrectly assumed. Most parents will name their spouse as the beneficiary and then name their children as contingent beneficiaries. If all of your children are adults this scenario works beautifully. However, if you name your minor children as beneficiaries you now have a huge potential problem. For example:

Case No. 1