Think carefully before naming beneficiaries

A will is actually simple: all it does is tell your heirs who gets what from your estate. Sure, the legal language is complicated. But designating beneficiaries is a piece of cake. All you have to do is . . .

Hang on just a minute. What you don’t know about beneficiary designations may end up costing your estate — and your heirs.

In actual fact, designating beneficiaries is neither simple nor straightforward. And if you don’t take care to do it right, you could end up creating a variety of unintended legal, financial, and personal consequences.

First off, don’t make assumptions. Instead, take time to understand some of the common pitfalls surrounding beneficiary designations, so you can be sure a decision about what to leave to whom doesn’t trigger an estate-planning disaster.

A good idea

Most beneficiary designations are made with good intentions: a desire to make an estate as simple as possible; an effort to reduce probate fees owing upon death; or a wish to provide equal distributions to one’s children.

To achieve these goals, many people rely on two tried-and-true estate planning strategies:

(a) Naming beneficiaries directly with assets that allow it. In most provinces, RRSPs, RRIFs, annuities, life insurance policies and some other assets let you name beneficiaries directly. (Québec is an exception—designations for RRSPs, RRIFs, and similar assets must be made in the will.)

(b) Owning assets jointly with heirs. Joint ownership with rights of survivorship is a common way to pass on larger assets such as the family house or cottage.

Normally these are good strategies: assets pass directly to the beneficiaries named, without going through probate. Not only can this save thousands of dollars in probate fees, it can also dramatically speed up the distribution process.

Unintended consequences

Problems arise, however, when people don’t think about how these strategies might clash with intentions in your will. Here are some examples:

Contradicting the will – In most cases, joint ownership and beneficiary designations made directly within RRSPs and RRIFs will override designations made in your will. So, if you own your house jointly with your first son, but designate your house to both sons in your will, your first son’s claim as a joint owner will take precedence.

Problems with asset transfer – Many people assume that beneficiary designations automatically transfer when assets such as RRSPs move from one financial institution to another. This isn’t always the case. In a worst-case scenario, an asset intended to be passed on to a particular heir ends up passing through the estate instead — all because a beneficiary designation was never updated or revised after a transfer.

Separation or divorce – A formal split with a spouse doesn’t automatically revoke a prior beneficiary designation. Each province handles this differently, but in most cases a new beneficiary designation must be made before a previous one is revoked.

Unequal taxes – In most jurisdictions, debts and taxes owed by the deceased’s estate must be paid before assets can be distributed; these costs are usually paid from the estate itself. This can result in a grossly unfair allocation of an estate’s tax burden. If, for example, you designate your son as the sole beneficiary of your RRSP, while leaving the rest of your estate to your daughter, your daughter could actually end up paying tax on your son’s inheritance.

Family conflict

Often the most devastating consequence of incorrect beneficiary designations is the legacy of conflict it leaves for the family.

Family members arguing over their respective shares of a deceased’s assets; children issuing legal challenges to a parent’s will; and bickering and squabbling to get their fair shares because of contradictory designations. All of it is not only possible, but probable if you fail to make beneficiary designations clear.

Wilmot George, CFP, TEP, CLU, CHS, is vice-president, Wealth Planning at CI Investments.