May 11, 2015

The Right Beneficiary

Written by jasonhiley

Over the years, one of the most common mistakes we have seen related to people’s financial affairs has been the incorrect naming of beneficiaries. Sometimes this is due to a lack of understanding around how a beneficiary designation works, or other times it may simply be due to an oversight. Whatever the reason, this can be a very costly mistake that is easily avoided.

Financial assets such as IRAs, life insurance policies, variable annuities, and 401k or other company retirement accounts are all payable based on the beneficiary designation. Many people do not realize that beneficiary designations supersede bequests made in a will or living trust. We often talk to people who believe they have all of their affairs in order because they recently created wills or trusts. Upon further review of their beneficiary designations, people sometimes find that those designations do not match up with the intentions laid out in their estate planning documents.

The most common reasons for these issues are due to people not updating their beneficiary designations after life changing events. Perhaps a sibling was named the beneficiary of life insurance policy prior to the insured’s marriage, or the contingent beneficiary of an IRA is missing the youngest child because they were not born when the account was opened. Whatever the reason, the best way to avoid these mistakes is to check your beneficiary designations on all relevant accounts on a regular basis.

When discussing beneficiary designations the focus is often on “who” gets what, but equally important may be “how” they get it. For parents with younger children, this aspect can be extremely important. We often like to ask new clients who have younger children whether or not they would be comfortable with their children receiving $1 million dollars when they turn 21 years of age. Generally the answer is a resounding NO!  However, these same parents often name their children as the contingent beneficiaries of their life insurance and retirement accounts. Should both parents be in a fatal accident, the contingency we just discussed would quickly become a reality. This reality can be prevented with proper planning. For many parents, going through the estate planning process can be the solution to these issues. A common strategy for this situation is the creation of a trust upon the death of both parents. The trust is then named as the beneficiary of any policies or accounts that utilize a beneficiary designation. This then allows for the parents to both provide for and protect their children as they grow and mature into adults capable of handling their own affairs.

Another important reason for naming a beneficiary of an IRA or retirement account is it gives your beneficiaries the ability to “stretch” the distributions of those accounts over their own life expectancy. If your beneficiary is your spouse, he or she has the option of treating your IRA as his or her own which would postpone required distributions until the age of 70 ½. If your beneficiary is a non-spouse, regardless of age, he or she will need to begin taking distributions from that account no later than December 31st of the year after your death. However, if you have set things up correctly, your beneficiaries will be able to take those distributions over their own life expectancies which can dramatically enhance the value of the account due to continued tax deferred growth.

To accomplish this, you must have a “Designated” beneficiary on file. This means that you specifically name that person on the institution’s beneficiary paperwork. If you fail to name a beneficiary, someone will inherit your account assets but it may not be the person you would have wanted. Furthermore, not naming a beneficiary will likely result in not being able to utilize the stretch provision. The rules around inheriting an IRA are very complex and tricky. I would suggest you talk to us when dealing with this situation. With more and more people accumulating wealth in investment vehicles such as IRAs and 401ks, proper beneficiary planning has become a critical, yet often overlooked, component of a financial plan. Take time to talk with your advisor about this issue to ensure that your hard earned wealth is protected. You owe your beneficiaries that much.