Estate planning is about much more than just a will or living trust. While many of your assets can pass to your loved ones through those documents, there are plenty more assets that cannot. These “non-probate” assets are ones that require you to name a beneficiary that will receive the assets when you pass, and include life insurance policies, annuities, 401k plans, IRAs, pension plans, stock options, and government benefit plans.
Choosing who you name as a beneficiary might seem like an easy task, but there are strategic considerations that must be taken into account when making this decision. Here are ten important things to consider when making, reviewing, or changing your beneficiary designations.
- Don’t forget to name beneficiaries – This may seem obvious, but its importance can’t be overstated. By naming a beneficiary, you maintain control over who receives your asset. If you don’t name a beneficiary, the governing agreement (for example, an IRA account) may mandate distribution of the asset to the owner’s spouse, surviving children, or estate, in that order. While usually helpful in the case of accidental omission of the beneficiary, it’s possible that the default beneficiaries may not be who you intended. And if the governing agreement doesn’t provide such a safety net, then the asset typically becomes part of the probate estate, which may result in delayed distribution, additional costs, or unfavorable tax treatment.
- Read the instructions carefully – Beneficiary designation forms are not all alike. Forms and governing agreements may vary significantly between financial institutions and for different types of assets or accounts. Don’t hurriedly fill in names. Read the instructions carefully to avoid mistakes.
- Name both primary and secondary beneficiaries – Naming a backup beneficiary protects your wishes when the primary beneficiary is unable or unwilling to receive the asset. For example, if the primary beneficiary predeceases you, naming a secondary beneficiary prevents the asset from ending up where you didn’t intend.
- (Perhaps) avoid naming individual beneficiaries for particular assets – Say you create three separate IRA accounts with equal assets, and you name a different loved one as beneficiary of each account. Then, over the years, each account performs differently than the others, and they end up with different values by the time you pass. If you had intended for each beneficiary to receive equal amounts, your intentions have not been accomplished.
- Coordinate non-probate assets with your will or trust – If you change the terms of your will or trust, make sure you consider the effect those changes will have on the distribution of all your assets, including ones where beneficiaries are named. A discussion with your estate planning team will help you see from a higher level how changes to any part of your plan affects the others.
- Avoid naming your estate as a beneficiary – For some accounts, this isn’t even an option, as an estate is not a person and won’t qualify as a “designated beneficiary.” But where it is allowed, this designation effectively converts a non-probate asset to a probate asset and may cause unfavorable tax consequences, particularly when taxable distributions must be made at an accelerated rate. A discussion with your CPA or financial advisor before making this election is advised.
- Be wary when naming a trust as a beneficiary – In some cases, as with some IRAs, annuities, or qualified retirement plans, accelerated taxable distributions may be required when a trust is named as a beneficiary. There are certainly some instances where naming a trust makes sense, like where there are minor children or in second-marriage situations, but you should consult with your CPA to make sure the effects of this designation are understood.
- Be aware of tax consequences and planning strategies – Working with your CPA or tax advisor on your beneficiary designations may uncover some unexpected tax consequences. Luckily, there are a number of planning strategies that can be used to minimize the tax effects that a particular beneficiary designation may have.
- Consider the use of disclaimers – For purposes of their own estate planning, it may be in the best interests of the beneficiary to decline assets they might otherwise receive as your named beneficiary. Disclaiming assets is a common tax-reduction or asset-distribution strategy that is often overlooked when naming beneficiaries. If you think a disclaimer may be made, designating a secondary beneficiary as a backup is a must.
- Review your designations regularly – Major life events happen all the time. Births, deaths, marriages, divorces – they all have an effect on your estate plan, including your beneficiary designations. For this reason, it is advisable to review your designations every few years and make adjustments as necessary.