Designating a direct beneficiary may be a common estate planning practice but doing so can also create more problems than it solves for the wealth transfer plans of high net-worth clients, particularly those in blended families, according to Christine Van Cauwenberghe, vice president, tax and estate planning, advanced financial planning, with Winnipeg-based Investors Group Inc., who spoke the Canadian Institute of Financial Planners annual national conference in Ottawa on Tuesday.
"Direct beneficiary [designations], in my personal opinion, are heavily overused," said Van Cauwenberghe. "And I think a lot of people don't think in the moment about what [they're] doing when [they] designate a direct beneficiary."
For example, naming a second spouse as the direct beneficiary of an account could lead to the client's biological or adopted children from a first marriage being inadvertently disinherited as the beneficiary can decide to pass on those assets to his or her own family.
As well, designating a grandchild as a direct beneficiary can prove equally challenging if the grandparents' intention is to have the parents manage the assets on behalf of that child.
"That's not the way the law works," said Van Cauwenberghe. "[Parents] are the guardian[s] of the child's person, but not [of] the estate."
As a result, the money that was intended to be available immediately may be tied up for years until the child reaches the age of majority.
Naming multiple beneficiaries on an asset can also backfire for clients. For example, in some cases, a client may name a spouse as the beneficiary for 90% of an insurance policy and a favourite charity as the beneficiary of the remaining 10%. However, if the spouse predeceases the client or happens to die at the same time as the client due to an accident, the second beneficiary, the charity, will receive 100% of the insurance policy, which may not in fact have been what the client intended.
Instead, Van Cauwenberghe believes that the client's estate should be the default beneficiary of their assets. "Name the estate, take the tax off the top, have the remainder flow to your kids," she said, adding that clients who feel the after-tax value of the estate is not enough of an inheritance should purchase insurance to make up the difference.
Although clients may not like the idea of paying probate fees, Van Cauwenberghe argued that the tax can be much lower than the final income taxes that beneficiaries may have to pay as well as the potential legal fees that may result from heirs disputing the distribution of the estate.
As such, it's important for financial planners to discuss the reasons why clients named specific individuals as direct beneficiaries. It's also still important that financial planners recommend clients have a will drafted by a lawyer, although the focus should be on an estate planning lawyer who has the trust and estate practitioner designation and who can explain the consequences of appointing a direct beneficiary.
Photo copyright: woodsy007/123RF