It’s common knowledge that the probate process can be lengthy and costly, especially if there is no Will. However, many folks view formal estate planning, like making a Will or Trust as a luxury they cannot afford.
Enter Beneficiary Designations: The Good
Beneficiary designations are the easiest and cheapest solution to minimize, or even avoid probate. When used correctly, beneficiary designations offer a way to transfer money and property directly to another individual without a legal process.
Everyone knows that you can designate a beneficiary on a life insurance policy or retirement account. But did you know that you can make a basic checking or savings account payable on death? The same goes for investment and brokerage accounts. Many financial institutions permit an account owner to name a beneficiary to receive the remaining account funds upon their death, through their depository agreement. Collecting the funds is easy. The named beneficiary simply presents the bank with a death certificate for the account holder and their photo ID, and they receive a check!
You can even designate a beneficiary on death for real estate. This option is available in many states, including Texas, by way of the “Transfer on Death Deed”. The deed states who takes the home or other real estate upon the owner’s death and is recorded in the county property records. In Texas, the Department of Motor Vehicles also offers a beneficiary designation form for vehicles.
Now for the Bad….
However, every beneficiary designation form or process has a limitation. Because most beneficiary designations are a creature of contract law, YOU MUST READ THE FINE PRINT! For example, some beneficiary designation forms like VTR-121 used by the Texas DMV, do not allow you to designate multiple beneficiaries. Other beneficiary designation forms like the Texas Transfer on Death Deed do not allow you to leave unequal shares when designating multiple beneficiaries. And some forms do not provide an “anti-lapse provision”—that’s when you designate someone and there’s a backup plan that re-distributes their share if they die before you do.
A common anti-lapse provision found in beneficiary designation forms is the election of a “per stirpes” distribution. Problem is: most people don’t speak Latin and don’t know what “per stirpes” means, so they just skip this option. Yet, electing this provision is especially important for parents naming multiple adult children with grandchildren. What happens if per-stirpes is not chosen when there are multiple children and grandchildren? If one child pre-deceases the account owner, the funds will only be distributed to the remaining surviving children. This effectively cuts out the grandchildren from the pre-deceased child.
Other “fine print” I have seen in beneficiary designation forms include garnishments for the payment of the deceased person’s debts! For example, most life insurance policies and bank accounts allow for the payment of funeral expenses before distributing to a beneficiary. But what if the deceased person had a personal loan with the same bank where they have a payable on death account? I have seen first-hand, where the depository contract effectively overrides state law concerning asset protection, and the beneficiary gets nothing! This is a truly unfortunate result because the probate and estate administration process in Texas provides a creditor claim process that is favorable to heirs.
Finally, beneficiary designation forms must be signed, acknowledged, and recorded somewhere. If a user messes it up, or the financial institution does, the assets WILL end up in probate. It is so important to follow up on all beneficiary designation forms and confirm that the designations have been recorded.
And finally, THE UGLY!
In my humble opinion, beneficiary designations should contain a caveat emptor warning (“Buyer Beware”), because I have routinely seen these forms cause expensive probate proceedings and even inheritance disputes.
Some of the ugliest cases I handled as a probate attorney that involved beneficiary designations were from account holders who had minor children. Parents who don’t make any kind of formal estate plan like a Will or Trust will do either one of two things on their beneficiary designation forms: (1) name their minor child as a beneficiary, or (2) name a “trusted” family member or friend as the beneficiary. Option two is by far the WORST option. Here’s why: a beneficiary has a contractual right to the money. Once the money is paid to them, it becomes their personal property. They can spend it on themselves. They don’t have to account to the minor children or a court. Additionally, the funds are subject to their own creditors (unpaid debts). This is a huge risk no parent should ever take! The problem with option one is that financial institutions will not pay out a sum of money to a minor child. Instead, the financial institution will hold the funds until the child turns 18. If the child’s caregiver needs the money sooner, they must petition a probate court to gain access to the funds (an expensive probate process called guardianship).
Things get even uglier for spouses under the Texas marital and community property laws. Texas has a law that says a final decree of divorce voids a beneficiary designation made to a spouse. However, that law only applies if the beneficiary designation was made during a marriage. If the designation was made outside the context of a marriage, the funds contractually belong to the named beneficiary. I have seen spouses effectively disinherited in favor of an adult child or other relative, because their spouse failed to change the beneficiary designations once they married, or re-married.
In these situations, I frequently have to tell probate clients “possession is 9/10ths of the law”. It’s really hard to dispossess people of money once it’s in their hands. In our estate planning practice, however, we routinely advise clients how to coordinate a beneficiary designation with a Will and Trust to avoid these poor outcomes altogether.
Do you have questions about beneficiary designations? Do you want to know more about how Trusts best avoid the probate process? Contact our office today!
