Like many Americans, you have worked hard, scrimped, and saved to have the same lifestyle you lived while working in your retirement years. You planned for retirement and put a will in place. You have worked with your financial advisor to make sure your investments match your objectives and risk profile. You are up to speed on recent tax law changes and how they affect your retirement accounts and financial plan. In short, you have done everything right and have left nothing to chance.
It has been several years since you last checked the beneficiaries on your IRAs, brokerage accounts with transfer-on-death (TOD) designations, annuities, or life insurance. Have you named your estate as a beneficiary on any of these accounts? What about a trust as a beneficiary? Have you committed one of the all-too-frequent mistakes in beneficiary designation that could expose those assets to taxation, litigation, or both?
I work with many people who believe they have a will in place, and it will establish their wishes when they pass. They fail to recognize that named beneficiary designations override wills.
Most financial companies allow you to name beneficiaries on non-retirement accounts, such as brokerage accounts, checking/savings accounts, etc. These are known as TOD (transfer-on-death) and POD (pay-on-death) accounts. You may also want to name beneficiaries differently on life insurance policies versus retirement accounts because of the different tax ramifications for each.
As we walk through common beneficiary mistakes, it might help to provide some definitions of the terms used here and in the financial services world.
Beneficiary- a beneficiary is any person who gains an advantage and/or profits from something.
Primary Beneficiary- the individuals or entities named to receive the money upon your passing.
Contingent Beneficiaries- the individuals or entities named to receive the money in the event one or more primary beneficiaries pass before the account owner. Should a primary beneficiary refuse the proceeds, then the contingent beneficiary will receive them.
When naming beneficiaries, it is essential to be clear and concise.
Avoid the following mistakes:
1) Not naming a beneficiary.
If you do not name a beneficiary, by default, your estate becomes the beneficiary. Then it becomes part of the lengthy, expensive, and cumbersome probate process. This means the money may not be available for your beneficiaries when they need it.
2) Naming your estate as beneficiary.
The probate process will have to be initiated to determine who should receive the inheritance according to the Will or Trust. This process will slow down, getting money to the people you want it to go to.
3) Failure to list contingent beneficiaries.
Suppose your primary beneficiary dies first, and there is no contingent. In that case, it is as if there was no beneficiary named. If the primary beneficiary does not want the assets because of tax implications or some other reason, it would be as if there was no beneficiary.
4) Not being specific.
Listing “all my children” is not specific enough. What happens in the event one of your children passes before you? This is especially bad if they had kids. Their kids, your grandkids, are left out.
5) Not naming everyone you want money to go to.
Just naming one of your three children with the expectation they will give their siblings their share of the money is not a good idea. If the child wanted to follow your wishes and get the funds to their siblings, the IRS might get involved and levy taxes on the amounts redistributed. The named child would not be required to provide the funds to the other children under the law.
6) Naming a minor as a beneficiary.
Children not considered adults (older than 18) will not be able to receive their proceeds. A conservatorship would be established, which can be costly until the child turns 18.
7) Naming a person with special needs as a beneficiary.
Individuals with special needs can lose valuable government benefits because they may own to many assets to qualify once they receive the inheritance. There are ways that you can provide for their care without creating these issues. A qualified financial advisor should be able to point you in the right direction.
8) Not updating beneficiaries over time.
Who you want to or should name as beneficiaries will most likely change over time. Just as your financial plan changes over time, so should your estate plan. For example, have you been divorced? If so, you probably want to update beneficiaries.
9) Not reviewing beneficiary designations with legal and financial advisors.
By naming beneficiaries, you are choosing who gets money as well as how much. Make sure the beneficiary designations follow your estate planning strategy.
10) Allowing for beneficiary designations to be completed in a “default” manner.
Many bank tellers and financial advisors complete paperwork in a certain way or out of habit, not considering your specific situation. They often neglect to ask you about “Per Stirpes,” which will include your beneficiary’s children should the beneficiary predecease you. Or they may input just enough information to get the account open rather than including clarifying points that would leave no doubt about who the beneficiary is. Another common mistake is not making sure that the whole account has an identifiable beneficiary. For example, naming 3 beneficiaries at 33% each, leaving 1% unaccounted for.
A vital component of any thorough financial plan is legacy planning. It is essential to ensure your hard-earned assets go to your beneficiaries in the most tax-efficient manner. I encourage you to talk to an advisor who is well versed in the laws governing the taxation and distribution of retirement plan assets and life insurance proceeds. They will be able to make sure the beneficiary designations work in tandem with your estate plan.
Investment Advisory Services are offered through Retirement Wealth Advisors, Inc. (RWA), an SEC Registered Investment Advisor. Stonebridge Insurance and Wealth Management and RWA are not affiliated. Investing involves risk, including the potential loss of principal. No investment strategy can guarantee a profit or protect against loss in periods of declining values. Opinions expressed are subject to change without notice and are not intended as investment advice or to predict future performance. Past performance does not guarantee future results. Consult your financial professional before making any investment decision.