How much does it matter to select the right designated beneficiary?
I was recently talking to a woman after her husband had died. He had a will giving everything to her. All his retirement accounts went to his ex-wife. This mattered a lot to the person hearing this news.
Your will does not control who inherits all your assets when you die. This is something that many people do not know. Instead, many of your assets will pass by beneficiary designations, says Kiplinger in the article “Beneficiary Designations: 5 Critical Mistakes to Avoid.”
A beneficiary designation is the form you fill out when opening many different types of financial accounts that states who will inherit the asset when you die. You select a primary beneficiary and, in most cases, a contingent beneficiary.
Typical accounts with beneficiary designations are retirement accounts, including 401(k)s, 403(b)s, IRAs, SEPs, life insurance, annuities, and investment accounts. Many financial institutions allow beneficiaries to be named on non-retirement accounts, which are most commonly set up as Transfer on Death (TOD) or Pay on Death (POD) accounts.
It’s easy to name a beneficiary and be confident that your loved one will receive the asset without having to wait for probate or estate administration to be completed. However, there are some problems that occur, and mistakes can get expensive.
Here are some common mistakes about designating beneficiaries that you don’t want to make:
Failing to name a beneficiary. We often see plans with either no beneficiary named or only a primary and no secondary beneficiary named. It’s hard to say whether people just forget to fill out the forms or if they don’t know that they have the option to name a beneficiary. Either way, not naming a beneficiary becomes a problem for your survivors. Each company will have its own rules about what happens to the assets when you die. Life insurance proceeds are typically paid to your probate estate if there is no named beneficiary. In this case, your family will need to go to court and probate your estate.
When it comes to retirement benefits, your spouse will most likely receive the assets. However, if you are not married, the retirement account will be paid to your probate estate. Not only does that mean your family will need to go to court to probate your estate, but taxes will be levied on the asset. When an estate is the beneficiary of a retirement account, all the assets must be paid out of the account within five years from the date of death. This accelerated payout, of what would otherwise be a deferred income tax liability, means taxes must be paid much sooner.
Neglecting special family considerations. There may be members of your family who are not well-equipped to receive or manage an inheritance. A family member with special needs who receives an inheritance is likely to lose government benefits. Therefore, your estate plan should include a Special Needs Trust for that person.
Minors may not legally be allowed to claim an inheritance, so a court-appointed person will claim and manage their money until they turn 18. This is known as a conservatorship. Conservatorships are costly to set up. They must also make an annual accounting to the court. Conservators may need to file a bond with the court, which is usually bought from an insurance company. This is another expensive cost.
If you follow this course of action, your heir may have access to a large sum of money at age 18. That may not be a good idea, regardless of how responsible they might be. A better way to prepare for this situation is to have a trust created. The trustee would be in charge of the money for a period of time that is determined by the personality and situation of your heirs.
Using an incorrect beneficiary name. This happens quite frequently. There may be several people in a family with the same name. However, one is Senior and another is Junior. The person might also change their name through marriage, divorce, etc. Not only can using the wrong name cause delays, but it could lead to litigation, especially if both people believe they were the intended recipient.
Failing to update beneficiaries. Just as your Last Will and Testament must change when life changes occur, so must your beneficiaries change. It’s that simple, unless you really want to give your ex-spouse a windfall.
Failing to review beneficiaries with your estate planning attorney. Beneficiary designations are part of your overall estate plan and financial plan. For instance, if you are leaving a large insurance policy to one family member, it may impact how the rest of your assets are distributed.
Take the time to review your designated beneficiaries, just as you review your estate plan. You have the power to determine how your assets are distributed, so don’t leave that to someone else.
Reference: Kiplinger (April 5, 2019) “Beneficiary Designations: 5 Critical Mistakes to Avoid”