Can Beneficiary Designations Replace a Trust?

Hands holding piece of paper with word Trust

Living trusts have become increasingly popular in the past decade or so. For many people, this estate planning tool is a straightforward way to pass assets directly to their intended beneficiaries on death, while bypassing probate. Recently, we have been receiving questions about using beneficiary designations to accomplish this goal without the need to create a trust. Can beneficiary designations replace a trust?

Beneficiary designations take a number of forms—and you probably have some in place already. For instance, if you have a retirement account at work, you likely had to name a beneficiary for the account.

Other mechanisms, like transfer-on-death (TOD) designations or payable-on-death designations also serve to transfer an account or asset outside of probate on the death of the owner. A joint tenancy with right of survivorship does the same for a piece of real estate. All of these devices are useful, but they don’t take the place of a trust. Here’s why.

Problems With Beneficiary Designations

Beneficiary designations, joint tenancies, POD and TOD designations all rely on naming another person to take ownership of the asset after your death. Unfortunately, death is unpredictable. What if your intended beneficiary dies before you do? Most of the time, the designation will not achieve your goal of transferring the asset.

Sometimes there is the option for a contingent beneficiary: someone to take the asset if the first named beneficiary is no longer able to. But in circumstances where there is not an option for naming a contingent beneficiary, or when the contingent beneficiary also dies before you, the asset will probably end up going through probate. This is exactly what you were trying to avoid!

There is another serious drawback with joint tenancies. Say you want your adult daughter to inherit your house. As long as she doesn’t predecease you, no problem, right? Wrong. The good news is whichever one of you survives automatically takes the house. The bad news is that naming your daughter as a joint tenant means that the house is now, legally, her asset as well as yours. That means if she gets sued and loses, her judgment creditor may be able to put a lien on the property.

Even if your loved ones are in excellent health, avoid accidents, and are unlikely to be sued, a trust is still a better choice than beneficiary designations and joint tenancy for one simple reason: you may need help managing your assets while you are still alive. Even if you are now fully able to take care of your property, there may come a day when you cannot. Many people become legally incapacitated years before they die, due to illness like a stroke or Alzheimer’s disease, or due to an accident or injury. A beneficiary designation only transfers an asset upon your death. It does not authorize a trusted person to manage the asset while you are still alive. Could your loved ones get guardianship over you and conservatorship over your property? Sure. But that can be costly and time-consuming, and your loved ones may dispute who should be in charge, and how things should be managed—probably not the outcome you were hoping for.

The Advantage of Trusts over Beneficiary Designations

A living trust offers you protection in the event of lifetime incapacity as well as transferring your assets at your death. You can put your house, your car, your bank accounts, your investments, and other assets into the trust. While you are alive and legally capable, you manage and use the assets in the trust just as you would if you owned them outright. Your trust will name a successor trustee (or two). In the event you become legally incapacitated, your successor trustee can step seamlessly into your shoes, managing trust assets according to your directions in the trust instrument.

In the event you become legally incapacitated, your successor trustee can step seamlessly into your shoes, managing trust assets according to your directions in the trust instrument.

At your death, the assets will be distributed, again according to your wishes as expressed in the trust instrument. Depending on the ages and needs of your beneficiaries, you might have the assets distributed immediately, or have them held in trust longer and “managed” by someone you hand pick for your beneficiaries’ benefit.  For example, it is very common for a client to want the share of a predeceased child to go to that child’s minor children. Only with a trust can you make that happen.

Living trusts intended for this purpose are generally revocable. This means that you can revoke or amend the trust at any time during your life (so long as you have legal capacity). You can add, remove, or change beneficiaries or switch up successor trustees. If you become unable to manage your affairs, your successor trustee can step in on your behalf. A power of attorney can also allow a person of your choosing to manage your financial business, but some financial institutions will not recognize a power of attorney drafted by another party. However, they will much more readily deal with the duly appointed trustee of a trust.

Beneficiary designations have their place. But they are not an effective substitute for a revocable living trust. If you are interested in creating (or updating) a trust, we invite you to contact our law office to schedule a consultation.

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Categories: Estates & Trusts

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