Don’t Let Clients Fall Into A Beneficiary Form Trap
September 12, 2014 by Linda Koco
Filling out the beneficiary form for annuities might seem simple. Just fill in the names and move on. But Jeffrey Levine, an individual retirement account (IRA) consultant with Ed Slott and Co., said those simple-looking forms might harbor traps for agents and advisors, and ultimately their clients.
One trap pops up if the client fails to update the beneficiary form — following a divorce or remarriage, for example.
The Supreme Court ruled long ago that the beneficiary form trumps other documents, Levine explained. The ruling concerned a general retirement account issue, not only annuities, but “annuities is a subset application in the real world,” he said.
So, if a man named his first wife as beneficiary but later divorced her and married another woman but neglected to change the beneficiary to the new wife, “the ex gets the money,” Levine said.
Advisors have to be cognizant of this, he told a breakout session at the recent annual meeting of the National Association of Insurance and Financial Advisors in San Diego. His presentation zeroed in on traps to avoid with IRA annuities (annuities that used as an investment inside of IRAs and Roth IRAs). Issues surrounding beneficiary forms was one area he discussed.
Bone up on per stirpes and per capita
Another possible trap has to do with two measures — per stirpes and per capita — that firms use in allocating estate assets (including annuities) upon death of the owner.
Per stirpes essentially says that the children of a named beneficiary receive the proceeds if the named beneficiary dies before the owner dies. Per capita says that only the named beneficiaries receive the proceeds.
Many times, people don’t take these measures into consideration when setting up their annuity, Levine said. The result can be that the annuity proceeds are not distributed as the owner had intended.
He cited the example of a male client with a $300,000 IRA annuity. The man leaves the IRA to his three children, each of whom has two children. Under a per stirpes arrangement, if one of the client’s three children predeceases him, upon the man’s death, each of the two surviving children would receive $100,000 from the annuity, and each of the two children of the deceased child would receive $50,000.
Most clients “think” in terms of a per stirpes arrangement, he said. They think that money automatically goes to their children or to the children of a child who has died. “It is not their intention to disinherit one section of the family because the child is not there,” Levine said.
A per capita arrangement is the opposite. In the above family, for example, the typical per capita arrangement would work out so that each of the two surviving children would get $150,000 and the two children of the third child, now deceased, would get nothing. Some definitions of per capita result in even worse outcomes, Levine said.
In some per capita situations, the children of the deceased might give some of their inheritance to the grandchildren because they believe that this is what the parents would have wanted, he said. But in other cases, the two grandchildren might be allowed to step up to make four beneficiaries, with each of them sharing equally in the $300,000.
The terms are defined under state property law. This means the terms can differ from state to state, he pointed out. “You should absolutely know these terms.”
It can be difficult for advisors to keep up with the differences, he allowed, especially for advisors who represent 10 or 15 companies, each with its own rules. Advisors need to find out which approach each company uses or makes default on the form, he said. “Are they per stirpes, or are they per capita?”
One solution is for the advisor to ask each company wholesaler which approach the company uses, he said. Then put the information on a simple spreadsheet, and update the spreadsheet as new products come out.
“One of the first questions you might ask the wholesaler is, ‘How does your beneficiary designation work? Are you per stirpes or per capita? Is there an option? Do you have a check box that allows you to hop into one of them?”
Levine said his firm typically sees per capita as the default measure in IRA annuities. However, he reiterated, “that is not how clients typically think about their money…and it may not be not what the client wants.”
In some of these cases, the advisor can write “per stirpes” across the form that has per capita as the default. The goal is that the annuity company will honor it. But not every company will honor per stirpes written on the form in that manner, he cautioned, “so you have to ask the company and you have to know the rules for each company.”
For instance, ask the wholesaler: “Can you write per stirpes on the form?”
In his firm’s experience, writing per stirpes on the form like that has been “largely acceptable by the carriers,” he said.
