When was the last time you updated, or even thought about, the beneficiary designations listed on your retirement accounts, life insurance, or annuity contracts? If you don’t remember, it’s definitely time to review!
How Beneficiary Designations Work
Beneficiary designations ensure certain assets owned by an individual transfer efficiently at her/his passing. Assets with designated beneficiaries transfer automatically, regardless of what is written in an individual’s last will and testament or trust document. It is also important to know that beneficiaries have no access or rights to an asset until after the individual’s passing.
Because the new owner is determined without the guidance of the will document, assets with designated beneficiaries are excluded from the decedent’s probate estate. The fewer assets that go through the probate process, the less cost associated with settling someone’s estate.
There are a number of different assets that transfer at death via beneficiary designation. These include retirement accounts (IRAs, Roth IRAs, 401(k)s, 403(b)s 457(b)s, pensions, etc.), life insurance death benefits, and the residual value of annuities. Beneficiary designations are important for accounts and policies that you have personally opened or purchased as well as those provided to you through your employer.
Types of Beneficiaries
Owners have the ability to name both primary and contingent beneficiaries. The primary beneficiary inherits the asset. However, if the primary beneficiary predeceases, then the contingent beneficiary becomes the new owner. If there is no contingent beneficiary listed, the asset will go into your general estate for distribution. For this reason it is important to name both your primary and contingent choices.
There are no restrictions regarding how many beneficiaries can be designated to inherit an asset. For example, if you have two children and wish to transfer equal shares of your 401(k) account to them after your passing, you would name both of your children as primary beneficiary and specify they would each receive 50 percent.
Charities can be named beneficiaries of assets, as well. Naming a charity as a full or partial beneficiary is a great way to transfer assets to an organization you care about at your passing. Since a charity does not pay income tax, leaving a taxable retirement account or annuity to a charity will allow 100 percent of the value to go toward the charity’s mission. If an individual inherits either type of asset, there may be income tax due either immediately or as funds are distributed.
A trust can also be named beneficiary. This is generally done to provide control over the asset to someone other than the inheritors. It is often used when minor aged children or individuals with disabilities are the ultimate beneficiaries. Using a trust as the beneficiary can be tricky and, therefore, it is advisable to do so only with the advice of an estate planning attorney or financial planner.
Simply naming your estate as the beneficiary of an asset is generally not a good idea. Doing so will subject the asset to probate and will produce unfavorable income tax treatment for retirement accounts. Please note that if you do not name a beneficiary where requested, the estate will become the default. Therefore, it is important to always name a beneficiary to avoid any potentially negative impact.
Review Periodically and Update as Life Changes
Take the time now to review your current beneficiary designations to be certain they reflect your desires. Whenever life circumstances change (marriage, birth, divorce, death), it is imperative that you update your selections as appropriate. A beneficiary designation can be changed at anytime as long as the owner is mentally competent to do so.
Coordinate Beneficiaries with Overall Estate Plan
Since assets with beneficiary designations transfer automatically, outside of a last will and testament or trust document, it is important to ensure that beneficiary designations complement your estate documents. For example, if you leave all of your assets to your child in your last will and testament, but have your ex-spouse listed as the beneficiary of your retirement account, the funds will transfer directly to your ex-spouse, not your child. Your estate attorney can provide guidance on how beneficiary designations should be stated in order to coordinate with your overall estate plan.
Because you work hard for your money, it is important to appropriately identify those who should inherit your property. Whenever you name or change a beneficiary, verify that the information was correctly recorded by the account custodian or insurance company. Mistakes are hard, if not impossible, to rectify after your passing.
Contributions were made to this article by Abby VanDerHeyden, a CFP candidate and Financial Planning Coordinator at Bedel Financial Consulting, Inc.
Elaine E. Bedel, CFP, is CEO and president of Bedel Financial Consulting, Inc., a wealth management firm located in Indianapolis. She is a featured guest each Wednesday on the WTHR (NBC, Indianapolis) Channel 13 News at Noon, "Your Money" segment. Elaine’s book, "Advice You Never Asked For… But wished you had," is available on Amazon.com. For more information, visit www.BedelFinancial.com or email Elaine at firstname.lastname@example.org.