A beneficiary designation is a contractual arrangement that allows you to designate who will receive certain benefits at your death. Beneficiary designations can only be used to transfer certain types of assets. Beneficiary designations are often used with life insurance policies, retirement plans (including pension-sharing, profit, and 401(k) plans), and IRAs.
Like other probate avoidance techniques, beneficiary designations work because they pass title automatically at your death, without any need for probate. For example, if you have named a beneficiary on your life insurance policy, there is no need for the probate court to validate the transfer to the beneficiary. You have made your wishes known in the beneficiary designation, and the insurance company is contractually obligated to follow them.
Many states allow the designation of “payable on death” (POD) or “transfer on death” (TOD) beneficiaries on banking, savings and loan, and other financial accounts. You may change the POD designations at any time and name alternate beneficiaries in case you are predeceased by a beneficiary.
Since a beneficiary designation does not give the beneficiary access to the asset until your death, it can be a better alternative than a joint tenancy in some situations. But beneficiary designations are only available for certain type of assets, such as financial accounts. For example, beneficiary designations cannot effectively dispose of real estate and many other types of assets. This limits the benefit of beneficiary designations in your overall estate plan.
Beneficiary designations also suffer from a major deficiency: they do not provide incapacity planning opportunities. The person named to receive the assets will get them at your death (which solves the issue of how to avoid probate), but they cannot access the funds during your lifetime (which doesn’t help you if you become incapacitated).
In other words, the beneficiary will not be able to access the funds for your benefit if you become incapacitated (e.g., through dementia or Alzheimer’s). Because living trusts both avoid probate and provide for incapacity, many clients incorporate living trusts or powers of attorney into their estate plan instead of relying on beneficiary designations alone.