Education >> Financial Basics

Do You Know Who Your Beneficiaries Are?

From Inside Personal Finance

Traditionally, people have associated “beneficiary” with life insurance, and beneficiaries were almost always the spouse and kids. Like so much else, though, it’s much more complicated today. As a result, the notion of naming your beneficiaries has become a major consideration in financial and estate planning. By selecting the right beneficiary, or combination of beneficiaries, you can greatly extend the potential value of your assets, reduce the amount paid in taxes, and materially improve your heirs’ lives, all while helping insure peace within the family.

Today, you find beneficiary designations in many more places than just life insurance policies. You’ve got to name beneficiaries on your company retirement plan, each of your IRA accounts, annuities, pensions and trusts. Do it correctly for most assets but forget one or two, and you’ve left your heirs with a big problem.

Ditto for today’s complex family units. In the old days, you likely had a spouse and kids. Today, it’s common to also have an ex-spouse (or two or three) in addition to a spouse, as well as step-kids (from one or more ex-spouses), as well as step-kids from your current spouse’s prior relationship(s). And, if you die in your 50s, 60s or 70s, you’re much more likely, than in any prior generation, to have parents or in-laws who survive you. Not to mention your siblings -- who themselves might be steps or halves. (A step-brother is the son of your step-parent; a half-brother is the offspring of your mother or father but not both.)
Yes, it’s All in the Family. And some families need scorecards.

Compounding the complexity is the fact that the law has not always caught up with today’s family units. In a 401(k), for example, the primary beneficiary must be your spouse, unless your spouse agrees to waive his/her rights. Yet, in many cases, the spouse is not the best choice. 

The result is that you must consider the size of your estate, how many (and which) family members are involved, and your attitude regarding inheritances. All this must be reviewed with your planner when making beneficiary designations. 

Let’s look at some of the common areas that require attention:

Retirement Accounts and IRAs: By shrewdly naming children and even grandchildren as beneficiaries, you can spread out the distribution of these assets for years, even decades, beyond your death. That’s extremely valuable, for the longer the assets remain invested in these tax-deferred accounts, the more they’ll be able to potentially grow. 

529 College Savings Plans: Each account permits only one beneficiary. However, you can change the beneficiary whenever you wish. So if a child doesn’t use all the money for college, you can name another. There’s only one restriction, and it isn’t very tight: Any substitute beneficiary must be a sibling, cousin, parent, grandparent or child of the initial beneficiary. (Yes, this means that unused assets can be used by the child’s future child -- enabling tax-deferred growth for many decades.)

Payable/Transfer on Death: Funds in savings and investment accounts can be paid or transferred after death to one or more named beneficiaries, while avoiding the probate process. (However, POD/TOD has no effect on estate tax liabilities.) During your lifetime, because you retain control of the assets, you can change or cancel beneficiaries.

Trusts: Trusts are often appropriate, especially when minor children are involved (because minors cannot inherit assets), when there are children from a prior marriage, when you expect your surviving spouse to remarry, if you have one or more heirs who cannot be trusted to use the money wisely or in accordance with your preferences, or if your estate (meaning the grand total of everything you own) is more than $1 million.

Insurance policies: With divorce severing about half of all marriages in this country, it’s not unheard of for an ex-spouse to collect the proceeds of a policy instead of the current spouse. I once had a client whose deceased mother was still listed as the beneficiary of a life insurance policy he had obtained before he was married. Fortunately, the situation was rectified before he died.

And beware these two common errors:

1. Failure to update beneficiary designations. We saw a case where a husband died after 17 years of marriage. He left behind a spouse and 5-year-old son. But his 401(k) went to his ex-spouse, someone he divorced 30 years ago after just six months of marriage. Turned out that he had never updated his beneficiary designation. 

Even if marital assets are divided via a divorce decree, nothing has changed unless you update your beneficiary designations on each account. Upon divorce or remarriage, or the birth or death of a current or potential beneficiary, you need to contact insurance companies, plan administrators, trust companies and mutual funds. As financial advisors, we routinely handle the paperwork for our clients.

2. Failure to designate contingent beneficiaries. If your primary beneficiary dies before you do, you should change your beneficiary designation. But what if you and your beneficiary die simultaneously, say from an auto accident or plane crash? You need to name secondary (contingent) beneficiaries as successors to your primary beneficiary.

If you haven’t reviewed your beneficiary designations lately, ask each of your account holders to tell you who is currently listed. You might be surprised to find that you’ve named as beneficiaries people who have died, or someone you’ve long since divorced. You might also discover that you’ve omitted the youngest three of your five children, simply because they weren’t alive when you opened the account. 

Remember: Insurance policies, IRAs, other retirement accounts, and annuities all require that you name beneficiaries; these assets are not governed by your will. Take action today -- before it’s too late.

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