Many people don’t understand that their will (or trust) doesn’t always control all of their assets. Some of a person’s assets pass by beneficiary designation. That’s accomplished by completing a form with the financial institution that holds the asset and naming who will inherit the asset upon your death. While legally effective, there are common beneficiary designation mistakes that can lay estate planning traps for the unwary.
Kiplinger’s recent article, “Beneficiary Designations: 5 Critical Mistakes to Avoid,” explains that assets including life insurance, annuities and retirement accounts (think 401(k)s, IRAs, 403bs and similar accounts) all pass by beneficiary designation. Many financial companies also let you name beneficiaries on non-retirement accounts, known as TOD (transfer on death) or POD (pay on death) accounts.
Naming a beneficiary can be a good way to make certain your family will get assets directly. However, these beneficiary designations can also cause a host of problems. Make sure that your beneficiary designations are properly completed and given to the financial institution, because mistakes can be costly and irreversible. This article looks at 5 common beneficiary designation mistakes to avoid when working with your financial institutions:
Failing to name a beneficiary at all. Many people simply never name a beneficiary for retirement accounts or life insurance. If you don’t name a beneficiary for life insurance or retirement accounts, the financial company has its owns rules about where the assets will go after you die. For life insurance, the proceeds will usually be paid to your estate. For retirement benefits, if you’re married, your spouse will most likely get the assets. If you’re single, the retirement account will likely be paid to your estate, which has negative tax ramifications. When an estate is the beneficiary of a retirement account, the assets must be paid out of the retirement account within five years of death. This means an acceleration of the deferred income tax—which must be paid earlier, than would have otherwise been necessary.
Failing to consider special circumstances. This is one of the most common beneficiary designation mistakes that I see. Reason being, not every person should receive an asset directly or outright. These are people like minors, those with specials needs, or people who can’t manage assets or who have creditor issues or a bad marriage. Minor children aren’t legally “competent” yet, so they can’t claim the assets. A court-appointed conservator will claim and manage the money (likely on an ultra conservative basis) until the minor turns 18. Those with special needs who receive assets may lose government benefits because once they receive the inheritance directly, they’ll own too many assets to qualify. People with financial issues or with creditor problems can lose the asset through mismanagement or debts. Ask your attorney about creating an inheritance trust to be named as the beneficiary.
Designating the wrong beneficiary. Sometimes a person will complete beneficiary designation forms incorrectly. For example, there can be multiple people in a family with similar names, and the beneficiary designation form may not be clear. People also change their names in marriage or divorce. Assets owners can also assume a person’s legal name that can later be incorrect. These mistakes can result in delays in payouts, and in a worst-case scenario, can mean litigation.
Failing to update your beneficiaries. Since there are life changes, make sure your beneficiary designations are updated on a regular basis.
Failing to review beneficiary designations with your attorney. Beneficiary designations are part of your overall financial and estate plan. Speak with your estate planning attorney to determine the best approach for your specific situation.
Beneficiary designations are designed to make certain that you have the final say over who will inherit your assets when you die. Avoid the common beneficiary designation mistakes above by taking the time to carefully and correctly choose your beneficiaries, periodically review those choices, and make the necessary updates to stay in control of your money.
Reference: Kiplinger (April 5, 2019) “Beneficiary Designations: 5 Critical Mistakes to Avoid”