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Best Practices for Beneficiary Designations

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April 01, 2014 | Barbara Baksa

Best Practices for Beneficiary Designations

Beneficiary designations are a surprisingly hot topic these days, with many experts now suggesting that they are not a good idea for stock compensation arrangements.  We've looked at this issue before in the NASPP Blog ("Did Steve Jobs Have a Beneficiary?," October 13, 2011), but we recently published the results of a quick survey on practices in this area, so I thought it would be a good time to take a look at the topic again. 

The Allure of Beneficiary Designations

When they work, beneficiary designations work very well. The company has clear instructions on what to do with the deceased employee's awards and can pay those awards out relatively quickly, with minimal documentation from the beneficiary (perhaps just a death certificate, instructions on how to distribute the awards, and documentation to complete any required tax reporting). 

Without a beneficiary designation, the awards transfer to the heirs in accordance with the rest of the deceased employee's estate. Unless some sort of trust arrangement that includes the employee's awards has been set up, this likely means that the awards will have to go through probate.  Depending on the size of the estate, probate can be expensive, can require the assistance of an attorney to navigate, and can take a long time (note however, that many states have expedited and simplified probate processes for estates that are less than a specified amount). 

When Beneficiary Designations Go Bad

The operative phrase in the section above is "when they work." When beneficiary designations don't work, things get ugly.  Beneficiary designations need to be regularly updated for life changes (marriages, divorces, births, deaths, etc.). And they need to comply with applicable local laws--in the US, state laws can inhibit the effectiveness of beneficiary designations; outside the US, this is even more of a problem.  Where the validity of a beneficiary designation is called into question, the matter will likely end up in court--which can be a lot more expensive and slower than probate. Of greater concern, where a company pays out an award pursuant to an invalid beneficiary designation, in some countries the company could be liable to the rightful heirs.

If you are going to allow plan participants to designate beneficiaries for their awards, you'll need a process for collecting and tracking the designations. You also really should have a process to remind participants to update their designations periodically--otherwise someone's stock awards could end up being paid out to an ex-spouse (as described in the blog entry noted above). And, particularly for non-US participants, you should have a process for verifying that the designations don't conflict with local laws. 

All of which seems like a lot of work for something that few participants will benefit from.  In the NASPP's recent quick survey on the topic, 87% of respondents reported that fewer than five participants die while holding outstanding awards per year. 

Survey Says

How many companies allow beneficiary designations anyway?  Well under half and sometimes as few as only one-third, depending on the type of award.  Among respondents to our quick survey:

  • 40% allow beneficiary designations for stock options
  • 37% allow them for restricted stock/RSUs
  • 32% allow them for performance awards
  • 35% allow them for ESPPs 

Note that for all four types of awards, there was a small percentage (less than 5%) of respondents that are considering or in the process of implementing beneficiary designations. The rest of the respondents do not allow them.

Of those that allow beneficiary designations and have non-US employees, 68% allow the designations for all of their non-US employees as well.

23% of respondents ask employees to update their beneficiary designations when they receive a new award and 12% ask for updates annually. 61% don't ever ask employees to update their beneficiaries, which seems like a good way to get into a situation where you are paying out an award to an ex-spouse.

43% of respondents store paper copies of beneficiary designations in house, 19% have some sort of in-house automated or electronic tracking system, and 32% rely on a third party to track the designations.

- Barbara

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