When it comes to estate planning, many people ask: Is it better to rely on my Will, or should I simply use beneficiary designations on my accounts?
To many people, it seems simpler to name beneficiaries on all their bank accounts and investment accounts, instead of having those accounts go through probate. In our experience as estate planning attorneys, it hasn’t been that simple—and in fact, it can even make the estate administration process more difficult.
Beneficiary Designations Can Delay Access to Funds
One of the most serious problems we encounter is that some major investment companies won’t release funds until the they receive a waiver from the state of Pennsylvania ensuring how the inheritance tax will be paid. This can cause a delay for the estate to have enough cash to pay the tax.
Beneficiary Payouts Can Complicate Inheritance Tax Payments
When settling an estate, our first goal is to pay the inheritance tax early—within 90 days—because that reduces the tax by 5%. But if beneficiaries have already received their shares (since they were named on accounts), we may need to ask them to contribute toward the tax.
Sometimes, those funds have already been spent—perhaps on mortgages or college loans—which can cause conflict among heirs. Some children may end up paying more than their share, leading to strain within the family.
Beneficiary Designations Override Your Will
Here’s a real-life example:
A father, after difficulties with his son, went to his lawyer to reduce the son’s inheritance so he wouldn’t receive the father’s investment account. However, the father never updated the beneficiary designation on that account.
The result? The son inherited the account anyway, because beneficiary designations take legal precedence over the Will. Meanwhile, the family was left battling over the money, and the account remained frozen until the house was sold to pay the inheritance tax.
Tax Complications With Retirement Accounts
Some people assume the IRA could be used to pay the inheritance tax. But that requires two things:
- The IRA beneficiaries must all agree to it.
- To pay inheritance tax from an IRA, income tax must be paid first.
For example:
- Let’s say the estate is worth $2.5 million, with the inheritance going to children.
- The inheritance tax is $112,500 (at 4.5%).
- If the children are in the 24% federal tax bracket, the income tax on that IRA withdrawal is another $27,000.
Result? The estate pays $139,500 in taxes instead of $112,500.
Planning for Contingencies Is Easier with a Will or Trust
Another issue with relying on beneficiary designations is what happens if a child does not survive you. You’d need to make sure your beneficiary forms state that the inheritance should pass to that child’s children (if that’s your preference).
With a Will or trust, this is much easier—you can simply state that each child’s share is left to them per stirpes (a legal term meaning that if a child dies before you, their share automatically passes to their children).
Managing Multiple Accounts Gets Complicated
Using beneficiary designations may sound simple, but it can easily create more work for you. If you have multiple accounts, you’ll need to track who is receiving what and ensure that each child’s total inheritance is equal.
Why a Will or Trust Is the Better Option
Our advice: A well-drafted Will or Trust is usually more flexible and can adjust to life’s unexpected changes far more effectively than beneficiary designations alone.
To ensure there are immediate funds available for taxes and expenses, a good rule of thumb is to set aside 8%–10% of your total net worth in cash accounts—or in accounts that can easily be converted to cash.
Final Thoughts
While beneficiary designations may seem like the easy solution, they often create more problems than they solve. A properly structured estate plan, built around a Will or Trust, provides clarity, avoids disputes, and ensures your loved ones are taken care of.
If you have questions about whether to rely on your Will or beneficiary designations—or how to structure your estate plan effectively—speak with one of our experienced estate planning attorneys.
