Beneficiary Designations 101

As financial planners, we are often asked about the importance of implementing beneficiary designations on retirement accounts, IRAs, life insurance policies, etc. Needless to say, many do nothing to update, change or review these options as major life events occur, i.e. death, divorce, job change, or the birth of a child. Costly tax, estate and other mistakes can be avoided with a little planning. The following are important to keep in mind as you plan your future, organize your financial affairs, and select options for tax minimization and deferral.

  1. Beneficiary designations at death control the benefit of tax deferral opportunities. It is important to set those up to maximize those benefits.
  2. Reviewing your retirement plan and IRA beneficiary designations at any life event, can save you costly tax mistakes, particularly when divorce occurs. The beneficiary form, not the divorce decree, determines who gets the participant’s share of the assets at the participant’s death. Accordingly, if the owner does not update his or her beneficiary designation, the ex-spouse may end up with their share of the funds.
  3. Keep copies of your beneficiary designations to avoid confusion on who the beneficiary is.
  4. Name a contingent beneficiary in the event of simultaneous death of the primary.
  5. Read your plan or IRA rules for choices to avoid a misunderstanding.

A few years ago, one of our clients lost a family member unexpectedly, who did not have any children and left the estate to him. Most of the liquid estate was held in an IRA account, which had not designated a beneficiary. As this was the case, MRDs (Mandatory Retirement Distributions) could not be made over the sole survivor’s single life expectancy. Instead, as in the case here, the owner of the IRA passed away before the required beginning date (70 for most), so the entire account had to be distributed by the end of the 5th year following the year of the owner’s death. Needless to say, this was not the most optimal tax & estate situation and could have been avoided with some financial planning.