Why People Use Beneficiary Designations
Many people name beneficiaries on their financial accounts, insurance policies, and retirement funds as a way to avoid probate. Probate is often seen as expensive, time-consuming, and public—things most people want to avoid. Assets with named beneficiaries transfer directly to the listed individuals, bypassing the probate process entirely.
While this may sound like a smart strategy, there are serious hidden risks that most people don’t realize until it’s too late.
The Risks of Naming Minor Beneficiaries
A common mistake people make is naming minor children or grandchildren as beneficiaries. The problem? Minors cannot legally inherit assets. When a minor is named, the inheritance is forced into probate court, where a judge decides who will manage the money until the child reaches adulthood.
Consider this real-world example: One of my clients had an ex-husband who unexpectedly passed away. He had named their minor children as beneficiaries on several accounts. As a result, my client had to go through probate to be named as their conservator, and the children’s inheritance was hit with the costly “kiddie tax,” costing tens of thousands of dollars in unnecessary taxes.
Even worse, once the children turn 18, they receive the full inheritance outright. I have a file full of stories about what happens when 18-year-olds inherit money—and it isn’t pretty.
Your Adult Children’s Inheritance is at Risk
Even if you name adult children, there are still serious risks. Once they inherit, the money becomes theirs—meaning it’s exposed to creditors, divorce settlements, lawsuits, and bankruptcy.
How Could This Happen?
- Divorce – If your child gets divorced, their inheritance could be divided as part of the settlement.
- Lawsuits – If they get sued, the inheritance could be seized by creditors.
- Medical Emergencies & Bankruptcy – According to a Harvard study, the leading cause of consumer bankruptcy is unpaid medical bills. Many of these individuals had health insurance, but gaps in coverage or lost income led to financial ruin. If your child inherits outright, their funds could be at risk if they face unexpected financial hardship.
- Poor Money Management – Some adult children simply aren’t good with money. Without protections in place, their inheritance could be gone in a matter of months.
A properly structured trust can prevent these risks by keeping the inheritance protected, allowing your children access when needed, but safeguarding the funds from outside threats.
What Happens if a Beneficiary Predeceases You?
Life is unpredictable. If a named beneficiary dies before you and you fail to update your designations, where does the asset go?
It depends on how the designation was structured:
- The asset might pass to that person’s spouse, siblings, or children (your grandchildren).
- If the grandchildren are minors, you’ve just created a probate nightmare where a judge decides who manages the funds.
- Worse yet, if your deceased child was divorced, the court may place their ex-spouse (the child’s other parent) in control of the money. Would you want your child’s ex managing your grandchildren’s inheritance?
This is an all-too-common mistake that could be easily avoided with proper planning.
Tax Consequences of Beneficiary Designations
Many people don’t realize that beneficiary designations can lead to unforeseen tax issues. Here’s how:
Estate Tax Issues
If your estate is subject to federal or state estate taxes, incorrectly structuring your beneficiary designations could have disastrous consequences.
For example, in Minnesota, estates worth as little as $3 million are subject to state estate tax. A family I worked with had trusts set up to minimize estate taxes, but they had been advised to use beneficiary designations on their accounts. The problem? The assets would go directly to their children, bypassing the trusts, and leaving no funds inside the trusts to cover taxes and expenses. This mistake could have cost the family hundreds of thousands of dollars.
Life Insurance & Unintended Tax Bills
I once saw a case where a man was required by a divorce agreement to keep his ex-wife as the beneficiary on a life insurance policy. Years later, he remarried and had a new family. When he passed, his ex-wife received the full life insurance payout—tax-free—but his current spouse and children were left to cover the estate tax bill out of their own pockets. Can you imagine paying the tax bill for your spouse’s ex?
Proper estate planning can prevent situations like this.
Trusts: A Better Alternative
While beneficiary designations may seem like a simple probate-avoidance tool, they come with significant hidden risks. Instead, many families choose a revocable living trust to:
- Control distributions – Ensure money is given to children or grandchildren at appropriate ages and under protected conditions.
- Protect assets – Prevent an inheritance from being lost in a divorce, lawsuit, or financial hardship.
- Minimize taxes – A properly structured trust can reduce estate and income tax burdens.
- Avoid probate – Just like a beneficiary designation, a trust allows assets to transfer outside of probate—but with protections in place.
Take Control of Your Estate Plan Today
A well-crafted estate plan ensures that your hard-earned assets go exactly where you intend—without unnecessary risks, taxes, or court involvement.
If you want to avoid probate, save on taxes and protect the money you leave for your children and grandchildren, call our Florida office at (941) 909-4644 or our Minnetonka, Minnesota office at (763) 420-5087 today to schedule your consultation. Or, you can fill out the contact form on this page and a member of our team will reach out to you to schedule your consultation.
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