Beneficiary designations: be very careful

Many life insurance policies and various savings plans (RRSPs, TFSAs, RRIFs) provide a means for you to designate a ‘beneficiary’, and on the death of the plan/policy holder the funds flow directly to the named beneficiary.

It is very common to name an individual as the beneficiary of the plan or insurance, rather than “your estate”.  For instance, it is commonly thought that by naming an individual beneficiary you can save probate taxes.

These beneficiary “other than the estate” designations are very dangerous – unless done with extreme care and as part of an integrated estate plan, they can be disastrous.

Here are some of the problems we have encountered recently:

• A beneficiary designation which stripped the estate of all its assets (as they were tied up in one insurance product), leaving the estate bankrupt (liable to pay taxes, but with no assets), and, leaving the entire estate plan including a life interest for the spouse completely moot.

• A designated beneficiary openly defying the actual wishes of the deceased and taking full ownership of the funds designated to him rather than splitting them, as he had promised, with his siblings.

• An advisor facing a negligence claim for recommending that his client change the beneficiary designation to name his executor personally rather than his estate, thereby rendering useless the prior estate plan and will.

Some financial advisors actively encourage their elderly clients to change the beneficiary designation from “the estate of …” to the individual who is also the executor of the will on the basis that this will avoid probate and the executor will handle the funds in accordance with the will.  This is terrible advice and puts the investment advisor at very substantial risk.

Risks for the testator

These designations can completely destroy your estate plan, and be extremely unfair to your intended beneficiaries.

Risk for the executor/designated beneficiary

If you are designated a beneficiary directly of funds you may be left unsure which funds you are to handle as part of the estate and which belong outright to the designated beneficiary.  Often, this will put you in a clear conflict of interest, forcing you to seek instructions from the Court.  If you are in a conflict, you must seek legal advice.  Further, you may receive the funds impressed with a trust, without clear trust instructions.  It is imperative that you ensure that you honour the trust and not breach of trust it by handling or distributing the funds differently form the intentions of the deceased.

Risks for the advisor

If you advise a client to make a beneficiary designation other than to their estate, you potentially expose yourself to very significant liability.  This is a terrible ‘probate avoidance’ strategy if it defeats the estate plan.  The recipient of the funds, even if the estate executor, may not handle the funds as if they were part of the estate.  The mere fact that they are the executor does NOT obligate them to treat the funds as part of the estate.  If the executor claims the funds as his/her own and not part of the estate, aggrieved beneficiaries may sue you for negligence.

Key points: if the intention of the testator is to have the funds dealt with as per the will, then name the estate not an individual as the beneficiary, or, have a properly documented trust to ensure that the designated beneficiary receives and handles the funds as per the original intentions of the deceased.