Most of the time, when people discuss estate planning, the focus is on their wills and trusts. However, the one thing that often gets overlooked is beneficiary designations.

The beneficiary designation works somewhat like a traditional trust – IRAs and 401(k)s are actually types of trusts. However, it has an entirely different function regarding the kind of assets it involves and who gets those assets. 

In this article, we’re going to talk about the very things that separate the definitions and functions of trusts and beneficiary designations—and the importance of a beneficiary designation.

Keep reading to learn more.

What Exactly Is a Trust?

When we talk about wills estate planning, there’s often a lot of confusion surrounding trusts, as in what they are, how they work, and whether or not you need to include one.

The quick definition of a trust is the fiduciary agreement you create allowing a third party—or a trustee—to hold and manage the assets meant to go to specific beneficiaries. 

There are all kinds of trusts, including irrevocable and revocable, charitable trusts, special needs trusts, medical trusts, etc. They all serve a slightly different purpose, but the goal is usually the same: To protect the specified assets named within the trust from estate taxes, future unknown creditors, liens, ex-spouses, nasty relatives, probate court, and so on until it’s time for them to be released to the chosen beneficiary.

You can think of a trust as an account of sorts, where certain assets are funneled into at the time of signing. With most trusts, no one can touch what’s in the account until a specific time or event, such as a health situation. 

The types of trusts that people are most familiar with are set up for an individual’s children. The assets in those trusts can be a certain amount of money, properties, possessions, and even business partnerships or holdings. Once the beneficiary hits a significant milestone in their life, the assets are then fully released in their name. Important milestones may be their college graduation, marriage, children, turning a certain age, etc.

Additionally, trusts are used to specify who is to get which assets. Once again, this ensures that those assets are protected and end up in only the specified beneficiary’s hands. 

Unlike probate cases, estranged or greedy family members have more trouble contesting a trust or attacking the transfer of assets within them. Once the trust is created, those assets become the personal property of the beneficiary.

What Exactly Is a Beneficiary Designation?

A beneficiary designation is another way of specifying who you want to inherit a specific asset. Only the beneficiary of said asset won’t become its owner until the time of the grantor’s (writer of the will’s) passing. 

The two most common assets listed under a beneficiary designation are retirement accounts and life insurance policies. 

It’s also possible and common to list your entire estate as a beneficiary designation. When this happens, your assets aren’t transferred to a specific person. Instead, they’re transferred to your estate. From there, your assets will be distributed accordingly with your last will and testament and any trusts attached to them.

Naming your estate as a designated beneficiary may seem redundant, especially in states like Alabama, where there are succession laws regarding inheritances. However, this is to ensure that specific individuals can and will gain access to your intangible assets.

Thanks to the recent SECURE Act, there are three classifications in terms of beneficiaries. These classifications are based on:

• The beneficiary’s relationship to the owner of the estate

• The age of the beneficiary

• The status of the beneficiary as either an individual or a non-person entity

To be considered an eligible designated beneficiary (EDB), the individual cannot be a non-person entity, such as a charity, trust, or estate. These things are considered not designated beneficiaries (NDBs). They are subject to different withdrawal rules as they have no life expectancy because they are not human entities. 

To be an EDB, the individual must be one of the following:

• A surviving spouse

• A minor child (under the age of 18)

• An individual with a disability

• An individual with a chronic illness

• An individual that is within 10 years of age of the deceased 

  Arguably, the most important thing to understand about beneficiary designations is that they revolve around the aforementioned intangible assets. These assets include retirement accounts like IRAs and 401(k)s and life insurance policies. 

The whole point of the beneficiary designation function is to ensure that the money within these accounts will transfer directly to the named beneficiaries without having to go through probate court. This further may allow the transfer to occur without the risk of being overridden or contested. 

The beneficiary designation function is set up within your will and within each account. This is why it’s essential to understand what a beneficiary designation is and exactly who you’re naming as the beneficiary of these accounts.  

What Are the Different Types of Beneficiary Designations?

There are several beneficiary designations, which means different rules for withdrawing the funds from each inherited asset.

As mentioned above, the most common designations are the eligible designated beneficiaries and the not designated beneficiaries. While the EDBs see more flexibility with the options to withdraw according to the 5-year rule or 10-year rule, the NDBs are still subject to the 10-year rule that was put into place before the SECURE Act.

Withdrawal rules aside, the other types of designated beneficiaries include:

• Designated beneficiaries (DBs) which is any living person that does not meet the EDB criteria but can still be named as beneficiaries to your intangible assets

• A primary beneficiary or the named beneficiary that is first in line to receive your benefits

• A contingent beneficiary who is essentially named as the second-in-line beneficiary in case the primary beneficiary passes away or  is unable or unwilling to accept the assets

• A secondary beneficiary is usually named explicitly as the second-in-line beneficiary but can also double as the contingent beneficiary

How Does a Beneficiary Designation Work with a Will and Trusts?

When it comes to wills and trusts, and designated beneficiaries, you can think of a last will and testament as the blueprint for your estate. It provides how you want your assets and possessions to be distributed and how you wish to proceed with your burial. 

The trusts and designated beneficiaries including in your will are essentially different outlines for different assets and their named beneficiaries.

The assets that fall under the “trust” category include tangible assets, such as physical money, real estate, high-valued possessions such as a car or artwork, and so on. The “designated beneficiary” category includes intangible assets such as retirement accounts, insurance accounts, and real estate accounts (which sometimes have property).

Generally speaking, a designated beneficiary will almost always override a will. This is because the assets involved are typically managed by an entire company, whether it be a financial institution or an insurance company. The assets never become the property of the decedent’s estate, so a will cannot transfer them in probate court.

There is no durable power of attorney (POA), executor, or trustor to manage the assets for a designated beneficiary. Therefore, the company in charge of those accounts are the only entities that can transfer those assets to the named beneficiary. 

Of course, this can sometimes conflict with what was initially written into your last will and testament. This is why it’s so important to ensure you review the provisions of your will and coordinate them with the beneficiaries you want to be named for those specific accounts. 

Failure to draw up the terms of your will and designated beneficiaries accurately will result in them being divided according to the state laws. And maybe not your wishes.

One way to avoid this confusion is by naming your estate as your designated beneficiary and using your will to define who will receive what and in what proportion.

Another way to avoid confusion is by contacting us today to consult with Sarah S. Shepard or another experienced Huntsville wills and estates attorney. Our Alabama lawyers will help to ensure that your estate planning goes smoothly.