All federal employees should have an estate plan. A complete and comprehensive estate plan includes properly filled out beneficiary designation forms. This column discusses what employees need to consider in avoiding the biggest mistakes in making their beneficiary designations.
First, it is important to review the most important beneficiary forms that all federal employees need to fill out and submit. These designations are:
• SF 1152. Designation of beneficiary for unpaid compensation of a deceased civilian employee, including the last deceased employee’s last paycheck and unused annual leave.
• SF 2823. Federal Employees Group Life Insurance (FEGLI) beneficiary designation; and/ or the beneficiary designation of an individual life policy if the employee has purchased an individual life insurance policy from a private insurance company.
Mistakes Federal Employees Should Avoid In Making Beneficiary Designations
• Not naming a beneficiary. If a federal employee dies while in federal service and has not filled out and submitted Form SF 1152, then the Office of Personnel Management (OPM) will pay out the decedent’s unpaid compensation and unused annual leave in an order of precedence. The order of precedence is a spouse, children, next of kin, executor of estate, etc. The problem is that OPM most likely does not know where these individuals live. OPM will eventually pay out the funds but after an unnecessary delay. Properly filling out and submitting Form SF 1152 will avoid this delay.
If an employee or annuitant who is enrolled in the FEGLI program does not name a beneficiary, then the Office of FEGLI will pay out the deceased employee’s or annuitant FEGLI insured amounts (this includes the FEGLI “basic insurance amount” and optional coverages) in an order of precedence and also with possible delay.
If a TSP account owner does not name a beneficiary, then the TSP will pay out a deceased owner’s TSP account in an order of precedence (spouse, children, and parents, appointed executor or administrator of the estate) and if none of the mentioned are alive, to the next of kin under the laws of the state in which the deceased TSP account was a resident at the time of death, with possibly delay. Another problem associated with order of precedence is that it may be completely inconsistent with a deceased’s estate planning goals.
• Not designating contingent beneficiaries. Often an employee will designate a primary beneficiary for their life insurance policy and TSP account but will fail to designate any contingent beneficiaries. A contingent beneficiary is the alternative choice to receive the proceeds of a beneficiary financial account if the primary beneficiary is not alive to accept the benefits of the account at the time they are paid. If a primary beneficiary – for example, a spouse – predeceases the life insurance policy owner or TSP participant, or if the life insurance policy owner or TSP participant and primary beneficiary die together, then the same consequences will result as if no beneficiary had been mentioned at all. Naming a contingent beneficiary will hopefully solve this potential problem when the primary beneficiary predeceases the life insurance policy owner or TSP participant.
• Failing to keep beneficiary designations up-to-date. “Life events” — for example, divorce and death – will necessitate an immediate review and updating of all beneficiary designations. If an ex-spouse remains as the named beneficiary of a life insurance policy, then upon the death of the insured the insurance company will most likely distribute the insurance proceeds to the former spouse, even if the deceased has remarried. If the primary beneficiaries predecease the insured or the pension plan/IRA owner, then it is essential for the insurance policy owner and pension plan/IRA owner to review and update their beneficiary designations at that time in order to ensure that the named beneficiaries are consistent with their estate planning goals.
• Naming minors as direct beneficiaries. Many parents establish testamentary trusts within their wills. The purpose behind the testamentary trust is to designate the age at which their minor children may have control over their parent’s assets. The problem is when a parent names a minor child as primary beneficiary of a life insurance policy or a pension plan/IRA. In that case, regardless of the testamentary trust that is part of the parents’ will, the life insurance proceeds and pension plan/IRA assets will go to the minor child with immediate access to a large sum of money. This is probably not in the best interest of the child. In general, it is better for parents to name their estate as beneficiary and allow the proceeds to go through the probate process in order to ensure they are distributed according to the testamentary trust established for their minor children.
• Naming “special needs” individuals as direct beneficiaries. Those individuals who name a “special needs” individual, such as a child or anyone receiving a governmental benefit such as Supplemental Security Income or medical assistance based on a disability, as direct beneficiaries could unintentionally disqualify that “special needs” individual from receiving government assistance and aid. In particular, if the “special needs” individual is named as beneficiary of a life insurance policy or a pension plan, then the individual would have to “spend down” the inherited assets and then reapply for government assistance. A better approach is to leave an inheritance for a “special needs” individual by creating a “special needs trust” within a will or trust. In so doing, they can safeguard an inheritance for the benefit of the “special needs” individual for their lifetime without jeopardizing their eligibility for government assistance.
• Naming financially irresponsible beneficiaries. Among some families, there is a chance that there are financially irresponsible individuals who should not be named as beneficiaries. If they are named as beneficiaries, there is a chance that the inherited assets could be claimed by creditors in a bankruptcy filing or by the IRS in a tax proceeding. An alternative for naming a financially irresponsible individual as a beneficiary is to create a lifetime “spendthrift trust” in order to hold an inheritance for the benefit of that individual for his or her lifetime while protecting the assets from creditors.
• Establishing an IRA beneficiary trust in order to make the trust as the named beneficiary of an IRA. With an IRA beneficiary trust, upon the death of the IRA owner, the IRA assets are paid into the trust and held in the trust for the protection and benefit of another family member. The problem is that this type of trust may create unnecessary complexities rather than facilitate the post-death administrative process for IRA beneficiaries. Before an IRA owner establishes an IRA beneficiary trust, they should talk to an estate attorney to make sure that this trust helps accomplish their estate planning goals.
Another mistake that some parents make in naming beneficiaries is to name a child as the sole beneficiary of a life insurance policy or a bank account. A parent with multiple adult children will sometimes designate one child as the sole beneficiary of a life insurance policy or a bank account, with the purpose of having this child use the insurance proceeds or bank account to pay the funeral or other final expenses. The remaining funds would then be distributed equally among the siblings.
The problem with this type of arrangement is that the child named as beneficiary is under no legal obligation to use this money for its intended purpose and could spend all of the remaining funds. Also, this child may be unable to distribute the remaining funds without incurring gift tax liability.
As the above discussion proves, beneficiary designations are an important part of the estate planning process. Making the right beneficiary designations will hopefully ensure that a deceased individual’s assets are passed on in the manner they choose and want.