When it comes to estate planning, there are many pieces to ensure that your heirs and loved ones are taken care of and have a clear understanding of your wishes. Any estate planning professional would tell you that the more you do while you are still living, the better. One of those items on the estate planning “to-do” list is making sure your investment accounts and life insurance policies have their beneficiary designations filled out.
You likely give some thought to selecting a beneficiary after starting a new job when you enroll in your company’s retirement plan, but then it probably fades into the back of your mind since no one likes to dwell on their mortality. However, it’s one of the most important aspects of estate planning.
Here are a few things to consider when you are making your beneficiary designations.
Name Primary and Contingent Beneficiaries in Coordination With Your Estate Plan
When you are prompted to name beneficiaries on your accounts, pension, or life insurance policies, you are usually given the option to name two levels of them: primary and contingent. A primary beneficiary is the first in line to receive, and a contingent beneficiary will receive should something happen to the primary before you pass away. You can name as few or as many people for each level, and you must assign a percentage to each person that adds up to 100% for how much they get.
If you fail to name any beneficiaries, then the account(s) will potentially go through probate, which would incur extra costs and drag the distribution process out. If you have no estate documents, known as dying intestate, and no beneficiaries are listed, then distribution will follow your state’s intestate succession laws. If married, your spouse will usually inherit by default, then your children afterwards. But if that is not the case, then it will end up with your parents, siblings, or other extended family.
If you had estate documents created, you want to make sure these designations match with the estate distribution flow in them, especially if trusts were created. We recommend consulting with your estate attorney on how to designate these properly to leave no room for error. Depending on the account provider, you may be able to do this online through your login, but there may be instances where physical paperwork must be submitted to name or update these. Additionally, you are not allowed to name a non-living legal entity, like a corporation, limited liability company (LLC), or partnership, as a beneficiary.
Do Not Name Minors as Beneficiaries
In most cases, a person will name their spouse as the sole primary beneficiary and then their children as equal contingent beneficiaries should something happen to both parents. This is a good stopgap, but if you have children under the age of majority (usually 18 or 21, depending on the state), this could create a guardianship issue should the absolute worst happen.
While they are under the age of majority, they cannot inherit the assets directly, and the assets will be put under the responsibility of a guardian until that age is reached. If there are no estate documents naming a guardian after the parents, then the court will appoint one. They will typically name another family member who is willing to step in, but it is not always the case, so having a will is crucial if you have younger kids to prevent this scenario.
If there are no estate documents, a guardian is named, and then when the child turns 18, they are fully entitled to those assets with no restrictions. However, if you do have estate documents created, you can push that age out or stagger it as desired to age 25 or 30, for example. I can imagine many parents out there would not want their 18-year-old getting access to potentially thousands of dollars unhindered.
Beneficiary Designations Will Supersede What You Have in Your Will
You may think that after putting in time, effort, and money into drafting your estate documents, these would rule supreme if something were to happen to you. However, this is a very common misconception.
Whenever you name a beneficiary on an individual retirement account (IRA), for example, whoever you list there can override whomever you may have designated in your will. This is because beneficiary designations are classified as an “operation of law,” meaning the account will directly transfer to the named person(s). These are essentially like having a contract with a life insurance or investment company, so they must adhere to it.
Depending on your state laws, your spouse will usually be the default, or can contest it if needed to get a portion or all of the IRA, for example.
Make Updates After Major Life Events and Review Periodically
As mentioned in the introduction, if you cannot remember the last time you looked at your beneficiary choices on your accounts, it may be time to do so. For our clients, we typically revise them after they get married, have a child or additional children, a listed beneficiary passes away, there is a divorce (depending on the terms of the decree where the spouse may need to remain as one for a period of time), or if they have trust(s) created, we would recommend doing the same.
In the event your 401k/403b, IRA provider, etc., may have changed, the new custodian you have will make you re-name the same beneficiaries either during setup or after the transfer, since that information is not shared between them. You do not want to be in a situation where a disgruntled ex-spouse is still named on an account and something happens to you. Likewise, you want to avoid a situation where you have not revised your beneficiaries since you started working, and you still have your parents or siblings listed, even though you have gotten married and/or had children since then.
You Cannot Disinherit a Spouse
As alluded to in the other tips, you generally cannot disinherit a current spouse when it comes to naming beneficiaries. Using North Carolina as an example, a spouse can take what is called an elective share of your estate, regardless of what your will may say. The amount they can claim here varies depending on the length of the marriage, but it can be up to 50%. However, each state will vary. If you live in a community property state, then your spouse is entitled to half of the assets acquired during the marriage by default.
There is one exception where a spouse may let a portion of what they are entitled to pass by them (or any beneficiary for that matter) if they make what is called a qualified disclaimer, which allows a beneficiary to refuse property. There are a few rules to satisfy if there is a disclaimer, such as it must be in writing and within nine months of the gift/inheritance, but you should consult with an estate planning professional about this, especially if trust(s) are involved.
You Can Name More Than Just People
There are some cases where individuals may not have any more family members around, never have children, or they were always charitably inclined during their life, where naming a cause or organization other than named individuals is a part of their estate plan.
This may be more common than you think, with people leaving money to their church, alma mater, medical research, or other groups they are passionate about. You do not necessarily have to name these as a beneficiary on your accounts and can typically do this with a specific bequest in your will for your chosen executor to donate a portion of your estate to the entity.
If you do end up naming an organization like this, you will need the entity’s full name and its tax ID/EIN number to include with the designations. Again, we would recommend consulting with an estate planning professional before making an update like this.
Do Not Name Your Estate as a Beneficiary
This is one of the biggest mistakes you could make when designating beneficiaries on your accounts and for your estate plan overall. We typically see this if someone does not have existing estate documents, and in their mind, it may seem like common sense. The main reasons not to name your estate as a beneficiary are:
- Probate costs: All assets set to be distributed where the estate is named as a beneficiary must go through the probate process in your state. This can incur longer resolution times, unnecessary legal fees, and so on.
- Creditors: If the estate is named directly as a beneficiary for an asset, then creditors have more ability to make claims on the estate versus having someone named directly, even for life insurance policies.
- 5-year “drain” rule instead of 10 years: This one mainly applies to IRAs. With the passing of the Secure Act, there is no more “stretch” IRA option for beneficiaries of these types of accounts, where only a small portion must be withdrawn annually for the beneficiary’s life. This was updated to the 10-year rule, where that account must now be fully withdrawn by the 10th year of the original owner’s passing. If their estate was named, then this is reduced to 5 years, which could create some tax issues for those who ultimately inherit.
Having an estate plan in place with the correct beneficiary designations can give you peace of mind that your wishes will be honored when you pass away. If you’re interested in learning more about how estate planning fits into your overall financial plan, please contact us.
