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Why Naming Beneficiaries Is Important

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Editor’s Note: How many times have you opened an account and skipped over the beneficiaries section? I know I do all the time. In fact, any one who has an ING Direct account has skipped over that section because that section doesn’t exist! In this article, Jeff Rose, a CFP in Illinois, shares a chilling tale of how skipping this section could have disastrous consequences you never envisioned.

Three sons were to be equal beneficiaries from their widowed mom’s estate. She had a modest home, about $100,000 in CD’s at the local bank, and $250,000 in an annuity. The mother named the eldest son executor of the estate. The family had always gotten along and the mother never imagined there would be an issue settling her estate, especially since her wishes were spelled out in the will - each son would get an equal third.

Sounds straight-forward enough, right? Wrong.

One minor item was overlooked and it proved to be the catalyst that drove the three surviving brothers apart.

The mother’s home and CD’s were divided without any problems in accordance of the will. It was the annuity that created the problem. When her husband had passed, she named her eldest son as the primary beneficiary on the policy. When she passed, the eldest son concluded that his mom had intended for him to receive the entire $250,000. So he kept all of the annuity to himself and as well as a third of everything else in the estate. Can that really happen? It can and it did.

Beneficiary Designation

Accounts that carry a beneficiary designation offer one of the simplest and most direct ways to efficiently get assets in the hands of loved ones after your death, but only if you have completed the paperwork properly and the information is up-to-date.

You might be surprised to learn that your will has no authority here. There are more accounts with beneficiary designations than you probably realize. IRAs, company-sponsored retirement plans (401k’s, 403b’s, TSP’s, etc), life insurance policies, Coverdell education savings accounts, and annuities, in trust for and pay on death accounts (TOD’s and POD’s), all have beneficiary designations.

Review Your Primary Beneficiaries

When deployed to Iraq, I almost forgot to change the beneficiary to my wife on my insurance policies. I had listed my parents as equal recipients because I set them before I was married. I would like to think that my parents would have done the “right” thing, but circumstances change when you receive a tax free check for $400,000. Don’t assume that your beneficiaries are correct – double check and make sure.

Contingent Beneficiary as Backup

Make sure you also have named contingent beneficiaries. These are the individuals or institutions who will receive your assets if your primary beneficiary is not available, either because they have predeceased you or because you wish to disclaim part of all your account.

Minors as Beneficiaries

Take care when naming a minor as a beneficiary. Unless the individual has attained the age of majority, which depends on where you live, they are not eligible to own financial assets. If you wish to leave certain assets to young children, such as grandchildren, you should appoint a guardian in your will to oversee these accounts until the beneficiary is no longer considered a minor.

Estate as a Beneficiary

If you don’t have a primary beneficiary or contingent beneficiary on your accounts, either because the individuals you named have died or because you simply specified anyone, your estate will become the beneficiary. In most cases, this outcome is not ideal. Assets left to your estate are subject to delays and costs of probate.  Unhappy heirs can contest the division of property, further delaying its distribution.

Trust as a Beneficiary

While naming a trust as a beneficiary of your account may seem like a simple solution, it can actually add a level of complexity when it comes to IRAs. If you want the beneficiaries of your trust to be able to stretch the IRA distributions  over their life expectancies.

529 plan.

A different but related issue is posed by 529 college savings plan. You should appoint someone you trust who can take over as successor account owner. This position is important because only the account owner of a 529 plan can change the beneficiary and authorize distributions.

It’s essential for you to review and update the beneficiary designations on a regular basis and whenever you have a major change in your personal circumstances, such as divorce, marriage, adoption, the death of a spouse, or birth of a child.

If you enjoyed Jeff’s post, read more of his stuff at Good Financial Cents, and subscribe to his RSS feed.

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18 Responses to “Why Naming Beneficiaries Is Important”

  1. Richard says:

    Good stuff! Think I’ll go review mine today… thanks for the advice!

  2. Walt says:

    In the example in the beginning, doesn’t the problem arise because of the way she designated beneficiaries in the annuity? It sounds like everything would have been fine if she didn’t designate anyone at all.

  3. Jeff Rose says:

    @ Walt

    In that particular case, you are absolutely right. Typically though, you want to name beneficiaries, especially if they are not spousal beneficiaries for stretch options.

    For annuities that are non-qualified (not in retirement account), you can also elect to get a five year payout option which can help with the tax ramifications. If no beneficiary is made, then it must be paid out immediately as accordance to the will. The amount that is taxable is only the amount that is above what was paid into the contract (premiums). In the case above, there was a pretty hefty tax liability that the elder son incurred.

  4. hustler says:

    Thanks. I checked around and did not have a beneficiary designated on my retirement account or my online savings account. I have since added my husband should anything happen.

  5. Lord says:

    You will generally want to specify beneficiaries per capita or per stirpes. Per capita goes to them and them only, while per stirpes goes to their heirs and assigns. A beneficiary that predeceases gets nothing under per capita with their share being divided between the remaining beneficiaries. A beneficiary that predeceases still gets a share under per stirpes that is divided amongst their heirs.

    • jillianlou says:

      That is actually not true. Per capita means if you have two beneficiaries and one predeceases you, the money is split evenly between the surviving beneficiary and the beneficiaries of the deceased, potentially leading the surviving beneficiary to get less than you intended. In per stirpes, the beneficiaries of the deceased split the deceased’s share, while your original surviving beneficiary gets the same share s/he would have originally received.

      Check out more at http://www.deathandtaxesblog.com/2007/04/per_stirpes_vs_per_capita_1.html

  6. Flexo says:

    I generally skip setting up a beneficiary. As a single guy, I suppose I could leave my assets to my cat, but I don’t think he will care nor do I think he’ll outlive me anyway.

    • jillianlou says:

      Do you have a good will? BC as a single person your assets could be in limbo depending on your state. At the very least you should name your parents or some other close relative as the beneficiary of a small life insurance policy or bank account to be able to pay your burial expenses in the event of an untimely death.

  7. Jeff Rose says:

    @ Flexo

    You could leave it for your cat, or…….

    Just fill the the following: Jeff Rose. I’ll forward you the rest of my info for your convenience :)

  8. Jeff-

    As a somewhat related point – also be sure to periodically review and, if situations or circumstances change revise, the executor/executrix named in your will.

    TWTP

  9. JoeTaxpayer says:

    Related directly to this, I wrote an article “On My Death, Please Take a Breath” http://www.joetaxpayer.com/archives/139
    I tell how a woman did everything ‘right’ beneficiary on her IRA which was all her money. She died and brother withdrew it all, getting hit with a huge tax bill. He has no income except SS disability, and would have been able to withdraw $9350 (the std deduction plus exemption) at zero tax rate, another $8350 at only 10%.
    I was sorry that he got me after the 60 days had passed, too late to do anything.
    When discussing beneficiaries, I tell people to include proper directions for withdrawals. This guy had no understanding an no one he could go to for guidance. A real shame.
    Joe

  10. Patrick says:

    I originally set up my beneficiaries to my father, who passed away not too long ago. Making sure to update that to my soon to be wife is really important. Thanks for the reminder, as things like this often get overlooked and can really become a big mess.

  11. Great post– super important to do this. No questions as to your wishes and streamlines the process of transfer to your beneficiaries.

  12. eric says:

    Nice post! Time to go review this.

  13. lynn grant says:

    I am the benificiary of my youngest son’s father’s TSP fund. My x-husband. There are 4 other son’s. How do I give them their fair share without tax consequences. I would like to “gift” tax free money to them would this be OK? Is it legal in a retirement und to do ths. I am 61 yrs. old the boys are in their 30′s. My youngest is 21 and it is his father who died.

  14. JoeTaxpayer says:

    As I understand the TSP (Thrift Savings Plan), it’s treated similar to an IRA or 401(k) in that withdrawals are taxed as ordinary income.
    Is the account still in the TSP? I’d suggest first doing a direct transfer to an IRA in your name, and then deciding how much to withdraw each year. As tax will be due, you want to withdraw limited amounts depending on your tax bracket.
    You may gift each son $13K/yr with no gift tax due or any reporting.
    Why do you feel it’s theirs? Do you not need these funds? At 61 you have a long life ahead of you and can make good use of this for the long term, but of course that’s your decision.

  15. Alyssa says:

    My aunt, sister and myself are listed as beneficiaries for my deceased grandmothers life insurance policy in virginia. I live in Georgia and am 8 months pregnant so I can not make it to the court hearing. Will the insurance money be split evenly between us even though I will not be present?


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