Designated Beneficiary Assets: Consider Your Income, Capital Gains & Estate Taxes
In the third segment of our series regarding Gift Tax & Estate Planning, we’ll examine assets that require designated beneficiaries, specifically: IRA accounts, retirement accounts, life insurance, accidental death insurance, annuities and payable on death accounts, which pass outside of a probate or a living trust.
Designated beneficiary assets must be looked at individually because different types of assets require different designations depending on their income tax consequences.
For example, a life insurance policy does not suffer any negative income tax consequences when being distributed upon the death of the insured – although it is exposed to estate tax consequences. Because of this, your revocable living trust can be named as the primary beneficiary of a life insurance policy.
There are important advantages to naming the trust as the primary beneficiary:
1. If you are married and have a trust that splits into two or more trusts upon the first spouse’s death for death tax planning purposes, the insurance proceeds can be utilized in the allocation of assets between the two trusts so that none of the decedent’s estate tax exemption is wasted.
If a surviving spouse is named as the primary beneficiary of the life insurance, the proceeds of the policy are not in the trust for allocation purposes and some or all of the decedent’s estate tax credit could be wasted.
2. If you have minor children and you name them as the direct beneficiaries of the life insurance policy, the proceeds will be subject to a Guardianship proceeding (court supervised) and held in an FDIC insured account (ensuring the account is held in an insured banking institution), which will be distributed to a child upon attaining age 18. This limits the asset’s growth possibilities, the ability for an adult to use those assets for that child during that child’s lifetime, and it gives a windfall to a child at age 18 when they may not be mature enough to manage money or get assistance managing money.
Remember: If minor children are direct beneficiaries of any asset, there will be a Court Guardianship proceeding which is expensive and time consuming.
It is better to name your trust as the beneficiary of life insurance for children so that the problems discussed here, do not occur. You may consider using a life insurance trust for the same reasons mentioned above, as well as for estate tax planning purposes – the life insurance trust will keep the proceeds of the death benefit out of your taxable estate upon your death.
If you have any questions about who to designate as a beneficiary for your assets, please contact me for help.
In my next blog, we’ll look into Retirement Assets, some of their potential problems and solutions to those problems. If you’d like to catch up on previous posts in this Gift Tax and Estate Planning series, click on the embedded links above to read about Living Trusts and Life Insurance.