Naming Beneficiaries: A Crucial Estate Planning Step
When it comes to estate planning, most people focus on creating a will or trust. They work with an attorney to craft legally binding instructions for how their assets should be distributed after they pass. However, one often overlooked, but equally important aspect of your estate plan is naming beneficiaries. In fact, properly designating beneficiaries is one of the most effective ways to ensure that your wishes are honored, and to avoid complications for your loved ones when you are no longer here.
What is a beneficiary?
A beneficiary is someone who will receive assets from your estate, life insurance policies, retirement accounts, or other financial accounts after you pass away. Beneficiaries can be individuals, such as family members or friends, or organizations, such as schools, places of worship, or charities. While many people understand the concept of a beneficiary in the context of a will, it’s important to note that beneficiary designations extend beyond legal documents. The process of naming a beneficiary often happens directly at the bank, retirement plan, or investment account.
Why does naming beneficiaries matter?
Many people are surprised to learn how much influence beneficiary designations have on the distribution of their assets. Naming beneficiaries has a direct impact on how your estate is handled.
Here are three key reasons why it matters:
1. Avoid probate: Probate is the legal process of verifying a will and distributing assets according to what the will states. It can be time-consuming, costly, and emotionally draining for your heirs. However, assets that are directly transferred to a designated beneficiary, such as a retirement plan or life insurance policy, generally bypass probate entirely. This means the money or property can be distributed much faster, and your heirs won’t have to wait for probate court to process your estate.
2. Make sure your wishes are honored: Without proper beneficiary designations, there’s a risk that your assets could be distributed in a way that you didn’t intend. For example, if you have an old life insurance policy and forgot to update the beneficiary after a divorce, your ex-spouse might end up receiving the payout. Naming beneficiaries ensures that your assets go to the right people and that your wishes are clearly documented and followed.
3. Make it easier on heirs: Family dynamics can be complicated, especially after a death. Without clear beneficiary designations, family members may argue over who should inherit specific assets, potentially leading to costly legal disputes. By naming beneficiaries in advance, you reduce the chances of conflicts arising. You also ease the burden on your loved ones, because they won’t have to guess at your intentions or battle over inheritances.
Where do I need to designate beneficiaries?
You may have more accounts or assets requiring beneficiary designations than you realize. Here are some common examples:
• Life insurance policies: The beneficiaries you name will receive the death benefit when you pass away.
• Retirement accounts (401(k) and IRAs): These accounts allow you to designate a beneficiary who will inherit your retirement savings directly, avoiding probate. If you are charitably inclined, this is typically the best asset to list a non-profit organization as a beneficiary because it allows the money to pass to the non-profit organization tax-free.
• Bank accounts: By using a Payable-on-death (POD) designation, bank accounts can be set up to transfer automatically to a designated beneficiary upon your death, bypassing probate.
• Investment accounts and real estate: Similar to a POD, Transfer-on-death (TOD) designations apply to investment accounts and property. These transfers also bypass probate.
• Wills: Your will may name beneficiaries for additional distributions that are not covered by direct beneficiary designations, as described above.
Does a designated beneficiary override a will?
Yes, a designated beneficiary will override instructions in your will. For example, if your will states that your life insurance policy should go to one person, but your policy’s beneficiary names someone else, the insurance policy’s beneficiary designation will take precedence. This is why it’s crucial to ensure your beneficiary designations are accurate, up-to-date, and consistent with your will.
What are the types of beneficiaries?
When designating beneficiaries, it’s essential to understand the different types of beneficiaries you can name. This helps ensure your wishes are clearly conveyed and that your assets are distributed correctly.
1. Primary vs. contingent beneficiaries
• Primary beneficiary: This is the person or entity who will receive the asset first, after your death.
• Contingent beneficiary: If the primary beneficiary cannot inherit the asset, due to death, as an example, the contingent beneficiary will receive the asset instead. It’s wise to name contingent beneficiaries in case the primary beneficiaries are unable or unwilling to accept the inheritance.
2. Per stirpes vs. per capita designations
• Per stirpes: If a primary beneficiary predeceases you, their share will be passed down to their descendants (e.g., their children).
• Per capita: If a primary beneficiary predeceases you, their share will be divided equally among the remaining primary beneficiaries.
3. Individual vs. organizational beneficiaries
• Individual beneficiaries: These are specific people, such as a spouse, child, or friend.
• Organizational beneficiaries: These are organizations, such as a non-profit or a trust, that will receive assets.
Who can be named as a beneficiary?
You have flexibility in choosing who can be a beneficiary. Here are some options:
• Spouse: A common choice, as spouses often inherit the bulk of a person’s estate.
• Non-spouse individuals: If you’re unmarried, you might name other individuals as your beneficiaries, such as children, parents, siblings, or close friends.
• Trust: If you have a trust set up, you can name the trust as a beneficiary, which may help in managing assets or providing for minor children.
• Non-profit organizations: Some choose to leave assets to non-profit organizations, ensuring their legacy continues through charitable efforts.
What are some mistakes to avoid when naming beneficiaries?
While naming beneficiaries is fairly straightforward, there are some common mistakes to watch out for:
• Naming vague beneficiaries: Naming your beneficiaries too vaguely, such as using “my children” instead of your children’s names, can create confusion and delay.
• Forgetting to update beneficiaries after major life events: Life changes such as marriage, divorce, births, or deaths should trigger an immediate review of your beneficiary designations. Failing to update them after significant events can lead to unintended consequences.
• Naming minors as direct beneficiaries: Minors cannot inherit assets directly. If you want to leave money to a minor, you should set up a trust to manage their inheritance until they reach the age of majority.
What happens if I don't choose a beneficiary?
If you don’t designate a beneficiary for an account or asset, it may be treated as part of your estate and go through probate. This can delay the transfer of your assets and create additional costs for your heirs. In some cases, the asset may be distributed according to state law, which may not reflect your wishes.
What are my next steps?
Naming beneficiaries is a simple yet crucial step in estate planning. To ensure your assets are distributed according to your wishes, it’s essential to review and update your beneficiary designations regularly, especially after major life events.
You can take action today by:
• Reviewing your beneficiary designations for life insurance, retirement accounts, bank accounts, and any other assets you hold.
• Ensuring your beneficiaries align with your current wishes and make any necessary updates.
• Consulting with an estate planner or Affiance Financial advisor to ensure your designations are correct and consistent across all your accounts.
Naming beneficiaries may seem like a small step, but it plays a significant role in ensuring your financial and personal wishes are honored. By taking the time to designate beneficiaries, you can provide peace of mind for yourself and your heirs, knowing that your legacy will be protected.
The views represented are not meant to be construed as advice. Moreover, no client or prospective client should assume that this content serves as the receipt of, or a substitute for, personalized advice from Affiance Financial, or from any other professional. Affiance Financial is not an attorney and no portion of this content should be interpreted as legal advice.
You should always consult an attorney or tax professional regarding your specific legal or tax situation. All investment strategies have the potential for profit or loss.
Sources: https://www.investopedia.com/terms/b/beneficiary.asp
