All federal employees, no matter their age and career status, should have an estate plan in place. A complete and comprehensive estate plan includes properly filled out beneficiary designation forms. This column discusses what employees need to do to avoid the biggest mistakes when making their beneficiary designations.
It is important to first review the most important federal employee beneficiary forms that all employees need to fill out and submit. These beneficiary forms cover certain federal employee benefits that are to be paid in the form of a lump sum payment in the event of the death of a federal employee or a federal retiree.
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These beneficiary forms are:
• OPM Standard Form (SF) 1152 (Designation of Beneficiary: Unpaid Compensation and of a Deceased Civilian Employee). This beneficiary form designates beneficiaries for any unpaid compensation and unused annual leave that is owed a federal employee who dies in federal service.
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• OPM Standard Form (SF) 2823 (Designation of Beneficiary: Federal Employees Group Life Insurance). This beneficiary form designates the beneficiaries for the FEGLI group life insurance.
• TSP – 3. (Designation of Beneficiary for TSP). This beneficiary form designates beneficiaries of a Thrift Savings Plan (TSP) account.
• OPM Standard Form (SF) 2808 (Designation of Beneficiary for employees covered by CSRS). This form designates beneficiaries for the lump sum payment of contributions made by CSRS and CSRS Offset employees to the CSRS Retirement and Disability Fund and not received by the CSRS or CSRS Offset annuitant (and survivor annuitant) as part of the monthly CSRS annuity (and survivor annuity) because the annuitant/survivor annuitant did not live to full life expectancy.
• OPM Standard Form (SF) 3102 (Designation of Beneficiary for employees covered by FERS). This form designates beneficiaries for the lump sum payment of contributions made by FERS employees to the FERS Retirement and Disability Fund and not received by a FERS annuitant (and survivor annuitant) as part of the monthly FERS annuity (and survivor annuity) because the annuitant/survivor annuitant did not live to full life expectancy.
The following are the 10 biggest mistakes to avoid when making beneficiary designations:
1. Not naming a beneficiary.
The following three examples illustrate what happens when a federal employee neglects to make a beneficiary designation:
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 to a spouse, children, next of kin, executor of estate, etc. A potential problem is that OPM may not know where these individuals live and therefore where to send the unpaid compensation. OPM will eventually pay out the funds but usually after an unnecessary delay. Properly filling out and submitting Form SF 1152 will avoid this delay.
If an employee or an annuitant who is enrolled in the FEGLI program does not name a beneficiary via Form SF 2823, then the Office of FEGLI has its own rules about where the FEGLI insurance proceeds will go after an employee/annuitant dies. Typically, the life insurance proceeds will be paid to the deceased employee’s or retiree’s probate estate. This means that deceased employee’s or retiree’s family will need to hire a lawyer, go to court and probate the deceased’s estate in order to claim the life insurance proceeds.
If a TSP participant does not name a beneficiary via Form TSP-3, then the TSP will pay out a deceased owner’s TSP account to a surviving spouse. But if a TSP participant is not married, the TSP account will be likely paid to the deceased TSP participant’s probate estate, which has unpleasant income tax ramifications. When an estate is the beneficiary of a TSP account, all of the assets in the account will need to be paid out of the retirement account within five years of the TSP participant’s death. This causes acceleration of the deferred taxes in the case of the traditional TSP,
2. 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 a contingent beneficiary. 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 lump sum benefits of an account. If a primary beneficiary – for example, a spouse – predeceases the FEGLI policyowner or TSP participant, or if the life insurance policyowner or TSP participant and primary beneficiary die together, then the same consequences will result as if no beneficiary had been named. In that case, the probate court will likely have to determine who should receive the lump sum benefits in accordance with the deceased’s Will or Trust or the deceased’s state default inheritance plan. Naming a contingent beneficiary prevents the unnecessary costs, delay and stress of probate, and ensures that the insured and TSP participant controls who receives the lump sum benefits.
3. Failing to review beneficiary designations. Life events — for example, divorce and death – 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 beneficiary predeceases the FEGLI (or other life insurance policy owner) or the TSP participant (or IRA owner), then it is essential for the insurance policy owner and the TSP participant (or 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
4. Naming minor children as direct beneficiaries.
While no one may stop a parent from naming a minor child on a beneficiary designation form, a financial institution is not allowed to pay benefits directly to a minor child. In case a parent does name a minor child as a beneficiary, the probate court will need to appoint someone to manage the child’s inheritance until the child reaches age 18 or 21, depending on state law. To avoid these unnecessary legal and administrative expenses, the parent should consult with their estate attorney as to whether the parent should establish a trust for the minor’s benefit subject the parent’s state Uniform Transfers to Minors Act (or, for some states, the Uniform Gifts to Minors Act).
5. Naming a “special needs” child as a beneficiary.
It is not common for a parent to name a child with special needs as a beneficiary on a beneficiary designation form without realizing that doing so may disqualify the child from receiving governmental assistance such as Supplemental Security Income (SSI) or medical benefits. It is therefore important for the parent to speak with an estate attorney to determine whether it is wise to name a “special needs” trust as beneficiary in order to allow benefits to pass to the special needs child without jeopardizing his or her access to governmental benefits.
6. Naming beneficiaries who are financially irresponsible.
Among families, there is a chance that there are financially irresponsible family members who should not be named as beneficiaries. If they are named as beneficiaries, then there is a chance that the inherited assets could be claimed by creditors in a bankruptcy filing or by the IRS and/or state revenue department in a tax proceeding. Under these circumstances, it is recommended that an estate attorney should create a trust specifically designed to manage the inherited assets for a financially irresponsible beneficiary and put some limits on how the inherited assets will be used (for example, for health and education) with outright control of the assets at a certain age when advisable.
7. Naming one’s estate as beneficiary.
Naming one’s estate as beneficiary does not mean that one’s executor of one’s Will or the trustee of one’s Living Trust has immediate control to distribute one’s assets to named beneficiaries. Instead, named beneficiaries will need to initiate the probate process in order to determine who should receive the inheritance in accordance with one’s Will or Trust or one’s state default inheritance plan if neither a Will nor a Trust has been prepared. The unnecessary costs, delay, and stress of probate can be avoided by naming the appropriate beneficiaries. Most importantly, naming beneficiaries ensures that an individual can control who receives his or her assets upon the individual’s death.
8. Establishing an IRA beneficiary trust in order to make the trust as the named beneficiary of an IRA.
When a trust is designated as the beneficiary of an IRA (a traditional IRA or a Roth IRA), 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 an IRA beneficiary 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, he or she should talk to an estate attorney to make sure that this trust helps accomplish their estate planning goals.
9. Failure to name beneficiaries for bank accounts (through a “Payable on Death” or POD designation) and to name beneficiaries for brokerage accounts (through a “Transfer on Death” or TOD designation).
Many individuals are not aware of the fact that they can name beneficiaries for their bank and credit union accounts (including checking accounts, savings accounts, and certificates of deposit) via a “Payable on Death” (POD) beneficiary designation. Similarly, many individuals who own brokerage accounts (in which they own stocks, bonds, open-end and closed-end funds, exchange traded funds and cash) can name beneficiaries of their brokerage accounts through a “Transfer on Death” (TOD) beneficiary designation. Each bank and credit union has its own POD form that a bank account owner has to fill out in order to establish a POD beneficiary designation. And each brokerage has its own TOD form that a brokerage account owner has to fill out in order to establish a TOD beneficiary designation.
10. Not reviewing beneficiary designations with legal and financial advisors. How beneficiary designations are to be made should be part of the overall estate and financial plan.
It is highly recommended that an individual gets his or her financial and legal professional advisers involved in order to determine what is best for that individual when it comes to distributing their assets at their death.
Beneficiary designations are designed to ensure that an individual has the ultimate say over who will get the individual’s assets upon the individual’s death. By taking the time to carefully and correctly select beneficiaries and then periodically reviewing those choices and making any necessary updates, the individual stays in control of his or her money. In short, that control is what proper estate planning is all about.
