When most people think about estate planning, they think about wills, trusts, and other legal documents. But there’s another important piece of the puzzle that can be easy to overlook: your beneficiary designations.
A beneficiary designation determines who receives certain assets when you die, including retirement accounts and life insurance policies. And in many cases, that designation can take precedence over what your will says.
That means a beneficiary form you filled out years ago could have a significant impact on who receives your assets—and how those assets are handled—after you’re gone.
What Is a Beneficiary Designation?
A beneficiary is the person or entity you name to receive an asset after your death. You may name beneficiaries on accounts such as:
- Traditional and Roth IRAs
- 401(k)s and other employer-sponsored retirement plans
- Life insurance policies
- Annuities
- Certain investment and bank accounts
You can typically name a primary beneficiary, who receives the asset first, as well as contingent beneficiaries, who would inherit if your primary beneficiary is unable to receive the asset.
For retirement accounts, the IRS has specific rules governing how and when beneficiaries must receive distributions after the account owner’s death. The rules can vary significantly depending on the beneficiary’s relationship to the account owner and other circumstances.
Your Will May Not Be Enough
One of the biggest misconceptions about estate planning is that a will controls everything you own.
It doesn’t.
Assets with beneficiary designations generally pass directly to the person or people named on the account. Retirement accounts and insurance policies can pass directly to named beneficiaries, and those designations can override instructions contained in a will.
For example, imagine you got married several years ago but never updated the beneficiary designation on an old 401(k). Your will may leave everything to your current spouse, but the retirement account could still be distributed according to the beneficiary designation on file.
Your estate plan and your beneficiary designations need to work together.
Life Changes. Your Beneficiaries Should, Too.
A beneficiary designation might have made perfect sense when you first opened an account. But life doesn’t always stay the same.
Major life events that should prompt a beneficiary review include:
- Marriage or divorce
- Birth or adoption of a child
- Death of a beneficiary
- Changes in family relationships
- Remarriage
- Retirement
- Changes to your estate plan
- The creation of a trust
- Significant changes in your financial situation
Even if nothing major has changed, it’s still a good idea to periodically review your designations to make sure they remain accurate.
And don’t forget about contingent beneficiaries. Naming a backup beneficiary can help ensure your assets have a clear destination if your primary beneficiary dies before you or otherwise cannot receive the assets.
Your Beneficiary Choice Can Have Tax Consequences
Beneficiary designations aren’t just about who receives your assets. They can also affect how those assets are distributed and taxed.
Retirement accounts are a particularly important example.
Under current federal rules, many non-spouse beneficiaries who inherit an IRA or defined-contribution retirement account after the owner’s death are subject to the 10-year rule, which generally requires the account to be fully distributed by the end of the 10th year following the owner’s death. There are exceptions for certain eligible designated beneficiaries, including surviving spouses, certain minor children, disabled or chronically ill individuals, and individuals who are not more than 10 years younger than the account owner.
Distributions from inherited traditional retirement accounts may also be taxable to the beneficiary.
This means the person you choose as your beneficiary could have a very different financial and tax situation than someone else.
For example, leaving a traditional IRA to an adult child who is already in a high tax bracket could have different tax implications than leaving it to a spouse or another beneficiary. Your financial advisor and tax professional can help you evaluate these considerations as part of your overall plan.
Don’t Forget About Special Circumstances
Sometimes, simply naming an individual as your beneficiary isn’t the best solution.
For example, if you want assets to ultimately benefit a minor child, someone with special circumstances, or multiple family members with different needs, a trust or other estate-planning strategy may warrant consideration.
Trusts can also introduce additional rules and complexities when they are named as beneficiaries of retirement accounts. Because beneficiary and estate-planning rules can be complicated, it’s important to coordinate with your financial advisor, tax professional, and estate-planning attorney before making significant changes.
A Beneficiary Review Can Be a Simple—but Important—Task
Reviewing your beneficiaries doesn’t have to be complicated.
Start by making a list of your financial accounts and insurance policies. Then ask:
1. Who is currently listed as my primary beneficiary?
2. Who are my contingent beneficiaries?
3. Are those people still the people I want to receive these assets?
4. Have any beneficiaries passed away or experienced a major life change?
5. Do my beneficiary designations align with my will and overall estate plan?
6. Have changes in tax law or my financial situation affected the strategy?
If you aren’t sure what your current designations are, contact the financial institution, retirement plan administrator, or insurance company that holds the account.
Don’t Let an Old Form Decide Your Future Legacy
Estate planning is about more than deciding what happens to your assets someday. It’s about making sure your wishes are carried out as intentionally as possible.
Your beneficiary designations are an important part of that process, and they’re often much easier to overlook than a will or trust.
Take a few minutes to review them. A small update today could make a meaningful difference for the people you care about tomorrow.
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This content is provided for educational purposes only. Commentary should not be regarded as a complete analysis of the subjects discussed and should not be relied upon for entering into any transaction, advisory relationship, or making any investment decision. The information presented does not involve the rendering of personalized investment advice and should not be viewed as an offer to buy or sell any securities.
Any tax information provided is general in should not be construed as legal or tax advice. Information is derived from sources deemed to be reliable. Always consult an attorney or tax professional regarding your specific legal or tax situation. Tax rules and regulations are subject to change at any time.