If you list an individual, trust or charity as your beneficiary, the proceeds of that asset typically go directly to the person or entity upon your death. Under most life insurance, retirement and IRA policies, as soon as the beneficiary provides proof of death and completes the necessary forms, the proceeds are distributed. In this way, the beneficiary receives the proceeds more quickly than if they were distributed through the estate and probate process.
If you list your estate as beneficiary, the proceeds will go through probate. Probate is the process by which a court verifies estate funds and property are distributed to the correct beneficiaries. The length of time the probate process takes varies by state and individual estate; however, it commonly takes a year or longer.
Estate Tax Implications
When deciding whether to name your estate as beneficiary, it is helpful to take any and all estate tax implications under consideration. Some states tax estate assets at higher rates than assets designated to a named beneficiary. Even in states where the choice of beneficiary makes no difference with respect to the tax rate, this choice will often have an effect on who pays related taxes. For example, if an estate is named the beneficiary of an asset, the estate pays the taxes due for that asset before it is distributed through the probate process.
When an asset is distributed directly to a beneficiary, in most states, the creditors of the estate have no claim to that money. If an asset is distributed to the estate and creditors are owed money, property in the estate, including the asset, must first be used to satisfy those creditors before being distributed under the terms of the will, if any assets remain. One creditor is the estate attorney. The attorney and estate administrator's fees are often a percentage of the estate's assets, so distributing an asset to the estate can increase these expenses.
Advantages to Naming Estate
Naming your estate as the beneficiary of your assets could have advantages. It allows you to create more complex distribution arrangements. For a small estate, for example, trust provisions can be written into the will, which keeps the estate simple and costs low. Naming the estate as the beneficiary in such a situation enables the funds to be transferred into that trust, without the need for a separate trust document.
IRA Tax Issue
There is a tax issue unique to IRAs. IRS rules are full of wrinkles, but whether an estate or individual is named as the beneficiary makes a difference in what the required minimum distributions are for the IRA after it is distributed to a beneficiary. In most cases, if you name a specific beneficiary, it will allow for a much slower payout of the asset than if you send the funds to the estate. With a slower payout, the beneficiary can minimize the taxes he pays on the IRA proceeds. However, there are exceptions to this common scenario. For example, when the individual to receive the IRA is older than you, naming the estate may end up providing a longer payout and lower amount in total taxes.