Who are your beneficiaries?
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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 time for a review!
How Beneficiary Designations Work
Beneficiary designations guarantee certain assets owned by an individual transfer efficiently at their passing. Assets with designated beneficiaries transfer automatically to the named beneficiary, regardless of the original asset owner’s last will and testament or trust document instructions. Named beneficiaries have no access or rights to an asset until after the original owner’s passing.
Because the new owner is determined without the guidance of a will document, assets with designated beneficiaries are excluded from the decedent’s probate estate. The fewer assets subject to probate, the less cost and time associated with the settling of the estate.
Many different types of assets transfer via beneficiary designation at the death of the original owner. 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. Bank and brokerage accounts can also be made payable on death (POD) or transferable on death (TOD) to a named beneficiary, if desired. POD and TOD designations bypass probate – like beneficiary designations.
Types of Beneficiaries
Owners can name both primary and contingent beneficiaries. The primary beneficiary is the first in line to inherit the asset. However, if the primary beneficiary predeceases, the contingent beneficiary becomes the new owner. If there is no contingent beneficiary listed, the asset transfers to the owner’s general estate for distribution. It is important to name both primary and contingent for this reason.
There are no restrictions on how many beneficiaries can 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 beneficiaries and specify they would each receive 50%.
Charities can be beneficiaries of assets, as well. Naming a charity as a full or partial beneficiary is a great way to transfer assets to an organization at a passing. Since a charity does not pay income tax, leaving a taxable retirement account or annuity to a charity will allow 100% 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 of an asset. Generally, naming a trust directs control over the asset to someone other than the inheritor(s). This strategy is often used when minor-aged children or individuals with disabilities are beneficiaries. Naming a trust as a beneficiary can be tricky, so it is advisable to do so with the advice of an estate planning attorney or financial planner.
Simply naming an estate as a beneficiary is typically not a good strategy. Doing so will subject the asset to probate and can produce unfavorable income tax outcomes for retirement accounts specifically. When no beneficiaries are named the owner’s estate will likely become the default, which leads to court probate proceedings.
Review Periodically and Update as Life Changes
Take time now to review current beneficiary designations to be certain they reflect current wishes. A general rule of thumb is to review designations every five years or whenever life circumstances change (marriage, birth, divorce, death). A beneficiary designation can be updated at any time 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 beneficiary designations coordinate with 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. Estate attorneys provide guidance on how beneficiary designations should be stated in order to coordinate with your overall estate plan.
Summary
It’s important to appropriately identify those who should inherit your property because you work hard for your money! 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.
Abby VanDerHeyden, CFP, is a Wealth Advisor with Bedel Financial Consulting, Inc., a wealth management firm located in Indianapolis. For more information, visit their website at www.bedelfinancial.com or email Abby at AVanDerHeyden@bedelfinancial.com.