Time to Check your Beneficiaries

Did you know there are assets that will not transfer to your heirs based on the instructions in your will? Instead, these assets transfer based on a beneficiary form you filled out.  While many advisors recommend you check your beneficiary designation forms any time you experience a major life event – birth, death, marriage, or divorce – we believe it’s a best practice to review your beneficiaries once per year.

Retirement savings accounts, such as IRAs, SIMPLE IRAs, SEP IRAs, 401k, 403b, and pension plans, annuity contracts, and life insurance proceeds are all assets that transfer based on the beneficiary designation and not through your will. Despite the importance of beneficiary designations, many people do not consult an advisor, attorney, or CPA before completing these forms.

There are a host of potential problems that can occur if your beneficiaries are not properly designated. Here are just a few examples:

Retirement savings or life insurance proceeds passing to an ex-spouse. Surprisingly, this is a common occurrence because many people forget to update old beneficiary forms.  One major potential downfall of this mistake is disinheriting children from a second marriage, at least in regards to these accounts.

Naming no beneficiary causes the assets to transfer to your estate. This can trigger immediate withdrawal rules, a tax bill, and allow creditors a claim on the assets. Remember, traditional IRA and retirement plans are tax-deferred accounts. When money is withdrawn from one of these accounts, it is taxed at the ordinary income rate. In the case of life insurance proceeds, they would be added back into the estate for estate tax purposes, negating the original intention of life insurance purchases completely, in many cases.

Naming a minor as the beneficiary. In most states, minors are not allowed to receive funds from life insurance, retirement plans, and annuities directly. Instead, the court must approve a legal guardian. This can lead to high court costs and often times, restrictions on the investments allowed in the account.

Leaving sizable assets to a child directly, when you really prefer the assets to be held in trust. Even if you have set up a trust under your will to ensure the child does not spend all the money at once, the child will have complete control of the beneficiary assets if you have designated them by name. Instead, designate the trust as beneficiary. The trust will also protect the assets from any potential creditors the child may have.

What happens if your beneficiary pre-deceases you? This is also a possibility and a reason to check your designations every year. Depending on how you filled out the form, the account many transfer to the pre-deceased beneficiary’s heirs; perhaps an unintended consequence. Or, the account may revert to your estate, again not a tax efficient strategy for most accounts.

How can you avoid making these mistakes? First, review all of your beneficiary designation forms to make sure they match the plan in your will. Review every IRA, ROTH IRA, retirement plan (for both current and previous jobs), annuity contract, and life insurance contract. You may consider meeting with an estate-planning attorney or CPA to help you with more complicated beneficiary situations.

Most importantly, be aware that beneficiary forms supersede the instructions in your will. Don’t assume that your will is taking care of everything. For many, a will may cover less than half of your estate, especially when considering life insurance proceeds.

– Blair duQuesnay, CFA, CFP(R)