Post-Divorce Estate & Beneficiary Planning
When you are in the throes of divorce, the division of assets, support issues and child custody concerns are prominent. This major life-changing event spills into your estate planning concerns and generational wealth transfer considerations.
Because you are now single and have assets awarded in your name or in the name of your trust as part of the divorce process, you need to consider their disposition for generational wealth planning. Putting off changing your will or beneficiary designations on your accounts can be costly.
Most states have statutory divorce laws that automatically revoke prior beneficiary designations. However, failure to change those designations will make the administrator of a policy assume it was your intention to leave that person as your beneficiary and let the terms prevail. Since many couples name their spouse as their beneficiary of life insurance, retirement accounts, etc., this makes it difficult to have the state laws take precedence.
Instead your beneficiary designations take precedence even if you have updated your will if your ex is still named on your life insurance policy, your retirement plan or your personal investments. The named beneficiary will automatically be entitled to those assets.
Therefore, it is crucial to update both your will and your beneficiary designations so that everything is consistent and there is no question about your wishes.
The timing of the update may not take place during the divorce proceedings because in most states there are automatic or filed court orders that prevent you from making such changes until the divorce is final. You should discuss these potential changes with your attorney prior to making any changes during the divorce as you could be violating state laws or court rules.
Minor children may not inherit assets directly. You likely will need to identify a guardian of any assets you would like to leave to your children. The guardian will manage and control the assets until your children reach the age of majority. Choose someone who is trustworthy and willing to act in this capacity. If you name any minors as beneficiaries on any policy or account, the custodian will not legally be able to honor your wishes and the issue will be remanded to probate court where the judge will assign a guardian of the accounts. That person may have very different ideas about how the account should be managed and invested. This can and should be avoided by naming a guardian, a trust or transfer pursuant to the Uniform Transfer to Minors Act or “UTMA” account as the beneficiary.
These options are described in more detail below:
1. If you do not name a guardian, someone such as a grandmother/aunt/brother may petition to be guardian but that is costly and time-consuming if you make no appointment. And there may be a conflict with the other parent who may seek custody of the account and file for guardianship as well.
2. Designate an UTMA account(s) as beneficiaries. There needs to be a Custodian for UTMAs. There should also be a successor custodian named to be extra cautious.
If placed in an UTMA, the funds will be distributed when the children reach the age of majority in the state in which the UTMA was established. This means the retirement amounts will be distributed to the children when they turn 18 (or in some states 21) if inherited as a minor, or, if they are enrolled in full time college/university, it can remain undistributed until they are 26. The accounts will need to be disbursed within 10 years starting at either 18 or 26.
There are tax consequences with this method, because if the children are still dependents at 18 and the funds are disbursed, the children would be taxed on disbursements at the parent's top marginal tax bracket.
3. Place the funds into a 529 plan for college could allow the funds to grow tax free until used for college. However, if the child(ren) do not go to college this will be problematic and withdrawal will mean a penalty for non-qualified use as well as taxes due and payable.
4. Place the IRA and 401(k) into a conduit trust as beneficiary, with a guardian appointed as trustee. This works well to say that either parent then would be the guardian in place of the other, and you can provide specific instructions as to how you want the guardian to handle the IRA distributions.
The trust would be required by law to disburse within 10 years as well. If the money was left in the trust, held for 10 years and then disbursed, all the dividends, interest and capital gains would be taxed at a much higher trust tax rate (37% starting at $2500 of cap gains/dividends).
The trust should be written by an estate attorney. You may want to consult with an estate attorney for this or other suggestions regarding inheritance of retirement accounts by minors.
Retirement accounts do not go to probate. They are handled with beneficiary designations only and any designation in wills consequently will not govern their disposition.
Be sure to adhere to whatever the divorce agreement stipulates in terms of named beneficiaries on assets awarded to you. If a divorce provision required you to name your spouse or child on a life insurance policy or disability policy for a period of time, then be sure that you are in compliance with that agreement. This is often required if there are spousal support or child support obligations. Failure to follow the agreement or order that is filed as part of your divorce decree may result in court action and/or sanctions.
Separately, your will, general and durable power of attorney and healthcare power of attorney should also be updated. In many states these powers of attorney may be changed during the proceeding of the divorce because in most cases, especially contentious divorces, you would not want your spouse who is typically the designed person to be making your legal, medical and financial decisions should you be incapacitated or near death.
This article does NOT constitute legal advice and is for general information purposes ONLY. Prior to making any decisions, seek legal counsel from a licensed attorney.
