It’s open enrollment season, which means that our law firm, like your company, has recently received notice of its 2023 health insurance coverage options. Having reviewed our firm’s coverage costs, well, let’s hope that 2023 brings good health, and few medical appointments, for my family as well as for yours.
As occasioned by this upbeat topic, in this month’s update I answer a few common estate planning questions that frequently arise in the context of naming beneficiaries on employee benefits. The specific beneficiary designation for Health Savings Accounts (“HSAs”), life insurance policies, and retirement accounts will vary based upon family and state residency circumstances, but a few general principles apply.
Health Savings Accounts:
For health savings accounts, married account owners should designate a surviving spouse directly as the primary beneficiary. A surviving spouse could “rollover” the remaining balance at death into her own account, and own that account as though she established it at the outset. The surviving spouse can then withdraw remaining HSA account assets for qualifying medical expenses free of any income taxes. For account owners who die with no spouse surviving, the designated beneficiary must pay ordinary income taxes on the inherited HSA assets. In those situations, the employee can either name his children, directly, or a testamentary trust created for her children.
Life Insurance:
For life insurance policies, the employee could name his spouse and/children directly as the beneficiaries. However, for our clients who have created a revocable trust, in most instances we recommend that the employee/insured name his own revocable trust as the 100% primary beneficiary.
Primary Beneficiary: 100% The Employee Trust Agreement.
This structure has two key benefits over naming the employee’s family members directly.
- For Minnesota resident employees with total assets exceeding the Minnesota estate tax exemption amount, the terms of the revocable trust would provide for the implementation of a Family Trust to hold death benefits for the benefit of the surviving spouse and family in a manner to minimize an estate tax burden following the second death.
- The life insurance death benefit would provide an excellent and tax-efficient means of funding a testamentary trust to meet the needs of named children or grandchildren.
Retirement Accounts:
For tax-deferred retirement account assets, the employee could name a spouse or adult children directly as primary and contingent beneficiaries. We often address two situations when a trust should be named as a primary or contingent beneficiary:
Married Minnesotan. If the surviving spouse of a married employee is named directly, the surviving spouse can “roll over” the account into his or her individual ownership, and not start taking distributions until age 72. Depending on the age of the surviving spouse, this may provide the surviving spouse significant income tax savings vis-à-vis naming a trust. However, as I summarized in an update earlier this year, if the surviving spouse faces the possibility of an Minnesota estate tax liability, this rollover benefit comes at a “cost” of increased estate tax exposure. For married Minnesota employees in this situation, I often recommend that the beneficiary designation include a “disclaimer” option so that the surviving spouse could “disclaim” assets to the family trust to achieve the desired estate tax savings. In these cases, the designation might look something like this:
Primary Beneficiary: 100%: Surviving Spouse.
Contingent Beneficiary: 100% The Family Trust created under the Account Owner Trust Agreement.
Single Employee With Trusts for Children. An unmarried employee who has created trusts for her children should name the trust(s) for children as primary beneficiary. If the children are minors, and if the trust is structured correctly, the 10-year “clock” on the payment of the income tax liability would not start until the children become legal adults. Regardless of the age of the children, the named trustee of the trust would have authority to manage the trust assets without any negative tax implications vis-à-vis naming children as direct beneficiaries.
As you interact with your clients during this open enrollment season, you might lament the impact of inflation on our health care costs, but also take the opportunity to confirm proper beneficiary designations.