A variety of financial accounts, including retirement plans and life insurance, allow individuals to designate beneficiaries. Whoever is named on a beneficiary designation form will receive those assets after the death of the owner — even if the will, trust, or other estate documents have different instructions.
“These forms are easy to file away and forget,” says Bethany Bryant, Regional Managing Director at Glenmede. “However, failure to coordinate with the estate plan or update the designations after marriages, births, deaths and divorce can have serious financial and emotional consequences.”
Smart Business spoke with Bryant about why and when to review beneficiary designations, and how those should align with an estate plan.
Why do beneficiary designations matter?
Paying attention to beneficiary designations is important because they dictate to whom that specific account gets distributed. Accounts or assets with a specific beneficiary supersede the owner’s will or other estate documents. For instance, a 401(k) account will pass to whomever has been designated as the beneficiary — it overrides the last will and testament, which is going to cover everything that doesn’t have a separate beneficiary designation form and may distribute to different individuals or entities.
Beneficiary designations also keep certain assets out of the probate estate. The process of validating a will and distributing assets, known as probate, can be costly and may take years to resolve, creating delays for heirs and loved ones. Outstanding debts held at death are paid out of the probate estate first, leaving those assets vulnerable to creditor claims. Because assets with beneficiary designations are not part of the probate estate, they transfer directly to the designated beneficiary.
Unfortunately, people often forget who they listed as beneficiaries. Changes happen in life, such as births, death and divorce, but people fail to actively revisit their beneficiary designations in conjunction with their estate plan, which can lead to significant problems.
What should be considered when making designations?
Not all beneficiaries are equal in the eyes of the law. A spouse has more options with an IRA than a non-spouse beneficiary. Grandchildren or younger generations could be subject to generation-skipping taxes. Naming a trust as a beneficiary, particularly of retirement accounts, can be very complicated. Federal law requires that spouses must be primary beneficiaries of certain qualified retirement plans or explicitly waive that right.
If a minor is designated as a beneficiary, a court-appointed custodian typically must be arranged to hold the asset while the beneficiary is a minor. For those whose estate documents designate a guardian or financial custodian, the court often honors that individual named, but leveraging a Uniform Transfer to Minors Act account is often cost-effective, and is another reason the will and beneficiary designations should align.
Designating a person with special needs as a beneficiary may disqualify them from receiving public assistance disability benefits provided by Social Security, Supplemental Security Income, Medicare, or Medicaid. Consider creating a Special Needs Trust to avoid jeopardizing benefits.
Leaving a pre-tax IRA to one or more charities is often a better choice because it will avoid the income tax that would be triggered on those assets if left to an individual.
When should these designations be reviewed?
Beneficiary designations should be reviewed with trusted financial advisers periodically, and specifically if there’s a significant life event. Often beneficiary designations are overlooked during the divorce process and that can create issues down the road if not addressed. Another time to review is when changing jobs and signing up for a new 401(k) or health savings account.
Whoever is designated, that’s who will get it. These designations always supersede a will. That’s why it’s important that all of these documents are coordinated, beneficiaries are selected carefully to ensure the desired outcomes are achieved. ●
This article presents general information and is not intended to be financial, investment, tax, legal or other advice. It contains information and opinions which may change after publication. Views expressed herein do not necessarily reflect the views of the author’s employer. No outcome, including performance or tax consequences, is guaranteed, due to various risks and uncertainties. Readers should consult with their own financial, tax, legal or other advisors to seek advice on their individual circumstances.
INSIGHTS Wealth Management is brought to you by Glenmede.
