Many people are confused about the way that life insurance, IRAs and other qualified retirement plans operate under their Wills. The short answer is, they don’t! Life insurance, IRAs and other retirement plans which are qualified for special tax deferment by the IRS (thus called qualified retirement plans) are beneficiary-driven.
This simply means that upon the owner’s death they will go directly to the person you have named as the beneficiary. A probate estate is what is passed on through your Will, and consists of property owned in your name only. A beneficiary designated asset essentially goes around your Will directly to the person or entity that you name as the beneficiary.
Beneficiary designated accounts are commonly referred to as non-probate assets. Assets that are required to pass through your Will are referred to as probate assets. There are many examples of non-probate and probate assets: Your IRA, 401(k), 403(b) and life insurance policies are non-probate assets, while a car titled in just your individual name is a probate asset.
Some assets could be either non-probate or probate, depending on how many people own the account. For example, a bank account that you own with your spouse is a non-probate asset because your spouse assumes full ownership upon your death.
However, a bank account that you own in just your name is a probate asset because you own it as an individual. A certificate of deposit (CD) is another example of an asset that could be either probate or non—probate. It would depend on whether you have named a beneficiary for the CD (not probate), or not (probate).
Understanding the distinction between probate versus non-probate assets is critical for proper estate planning. People often mistakenly believe that when they make a Will, they are disposing of all of their property according to the instructions in the Will. This would only be the case if the beneficiary designations on their non probate assets match the instructions contained in the Will. Remember, the Will is not going to have anything to do with who receives that beneficiary driven account, or any other account that is a non-probate asset.
Take for example the case of John, the Widower. John has two children: a daughter, Jane, who is quite successful; and a son, Tom, who is not. Jane has told her father that she does not need his estate assets as much as Tom, and encourages him to do more to help Tom after his death. Accordingly, John creates a brand new Will in which he leaves 80% of his estate to Tom and only 20% to his more successful daughter Jane. John is happy that he can help Tom more after his death, and he assumes he has created an effective estate plan to accomplish his wishes.
Unfortunately, when John set up his 401(k) retirement plan at work decades ago, he naturally named his wife as his primary beneficiary and his then-young children, Jane and Tom, as equal (50% each) secondary beneficiaries. He did the same thing for his $200,000 life insurance policy he purchased not long after he started working. Because John’s wife has already passed away, Jane and Tom are now equal beneficiaries of his retirement plan and the life insurance policy.
Other than his 1985 Buick, these are really the only assets that John owns when he dies not long after creating his new Will. Unfortunately, because he failed to match his beneficiary designations with his new Will, when John passed away, Tom only received 50% of the 401(k) and Life Insurance policy; a far cry from the 80% John wanted his son to receive. The only asset left to divide 80%-20% was that faithful old 1985 Buick.
You can see how important it is to be mindful of the impact of non-probate assets when planning your estate! To find out more about this and all things estate planning and/or asset protection planning, join us for one of our upcoming workshops. Just click here for more information.