9 Mistakes to Avoid When Naming Beneficiaries
By Mitchell J. Smilowitz, CPA
Naming beneficiaries for your retirement account – as well as other assets you own – is a fundamental, but often over-looked, part of your financial plan. We establish a beneficiary when we first open the account and then often forget about it. Like any part of your financial plan, it is useful to review your beneficiaries every few years or after a major life event such as a wedding, a divorce, the death of a loved one or birth of a child, to ensure you are not making one of these 9 mistakes.
This article focuses on beneficiaries chosen for your retirement accounts and life insurance. These accounts will always be inherited by the designated beneficiaries on file regardless of what is written in your Will or Trust. Your Will or Trust govern the disposition of assets such as real estate, bank accounts and other non-retirement investments.
What are the mistakes to avoid?
#1 – Not Designating a Primary Beneficiary
When you have not designated a beneficiary – or beneficiaries – for a retirement account or a life insurance policy, inheritance of those assets is governed by law in the state in which you live. Make sure all of your accounts and policies name the beneficiary you want to receive the proceeds – your spouse, children, other family members, friends, etc. The JRB requires you to establish a primary beneficiary when you open your JRB account. The primary beneficiary will also receive the proceeds from the term life insurance you receive as part of our Complimentary Insurance Program.
#2 – Not Designating a Contingent Beneficiary
A contingent beneficiary inherits your assets if your primary beneficiary predeceases you. If you have not named a contingent beneficiary and your primary beneficiary has died, your assets will be treated as if you had not named a beneficiary at all. In other words, the distribution of your assets will be determined by state law where you live. While not required, the JRB strongly recommends that you name a contingent beneficiary for your JRB retirement account. Many participants name their spouse as their Primary Beneficiary and their children as Contingent Beneficiaries, but you can also name another family member, close friend or anyone else you’d like.
#3 – Not Adding a Per Stirpes Designation
Adding a per stirpes designation allows a deceased beneficiary to pass their inheritance to their heirs. Without the designation, the portion going to a deceased beneficiary would be divided among the surviving named beneficiaries. For example, assume you named your spouse as the Primary Beneficiary and your two children as Contingent Beneficiaries. If your spouse and one of your children predecease you, with a per stirpes designation, the half that would have been inherited by the deceased child would go to your grandchildren from that child; your other child would continue to receive ½ of the assets in your retirement account. Without a per stirpes designation, all of the assets would be inherited by the surviving child only.
#4 – Naming an Estate or Trust as Beneficiary
Naming an estate or trust as beneficiary presents unique challenges. Estates and trusts are usually required to liquidate all assets within five years and are often expensive to administer. Individuals generally have more than five years to liquidate assets. Spouses can stretch payments throughout their lifetime and non-spouses get at least 10 years. Stretching payments over a longer time period allows beneficiaries to withdraw the funds more slowly. Slower annual withdrawals can reduce taxes by keeping the beneficiary in a lower tax bracket.
Additionally, retirement accounts and life insurance are two instances where your assets can pass to your beneficiaries outside of probate. Avoiding probate means your beneficiaries have much quicker access to the funds in your retirement account and life insurance policy. Listing your estate as the beneficiary puts the assets back into the probate process, delaying the time when your beneficiaries can access the funds.
Trusts and estates also carry administrative costs that individual beneficiaries do not incur. They have to be administered and must file an annual tax return. Trusts and estates need to stay open for as long as there are assets in the account. These costs are paid by the trust or estate, reducing the funds available to your heirs.
It can make sense to name your estate or a trust as beneficiary, but you should consult an estate planning professional to determine if this makes sense for you.
#5 – Having Outdated Beneficiaries
Outdated beneficiaries are a disturbingly frequent occurrence. Many people set a beneficiary and never review it. Many years later, their heirs find that the named beneficiary has already died. Or, the named beneficiary is a former spouse. Or, that one or more children are not named as beneficiaries.
Make sure that the beneficiaries you’ve named for your JRB account, other retirement accounts and life insurance policies reflect your current desires.
#6 – Naming Minors as Direct Beneficiaries
If you name a minor as your beneficiary, it is important that you also name a guardian in your Will. Many institutions, including the JRB, will not pay benefits directly to a minor. If one is not named in your Will, a probate court will assign a guardian to manage the inheritance.
#7 – Naming Special Needs Individuals as Direct Beneficiaries
Naming special needs individuals as direct beneficiaries raises an additional issue. Many government benefits available to special needs individuals are income based. Naming a special needs individual as a direct beneficiary may disqualify that person from receiving government assistance. While there are many reasons to avoid naming a Trust as beneficiary, it may make sense to do so for the benefit of a special needs individual.
#8 – Naming Different Children as Beneficiaries for Separate Accounts
If you have more than one retirement account or life insurance policy, assigning separate accounts to each child looks like a simple solution. But consider this. While the amounts may have looked equal when you set up the beneficiaries, over time the balances may grow disproportionately. Naming all of your children as joint beneficiaries of each account assures each beneficiary will receive the amount you intend.
#9 – Naming One Child as the Sole Beneficiary
A parent with several children may designate one of them as the sole beneficiary of an account with the thought that this child will use the proceeds to pay for the funeral and distribute the rest to their siblings. However, your child is under no legal obligation to use this money as you intend. Designating the proceeds from your account to a single child also increases the tax liability for that child. This can make it more difficult and costly for the child to carry out your wishes.
Conclusion
Don’t make these 9 mistakes! If needed, contact your attorney to review your estate plan and contact the JRB via email or call 888-JRB-FREE (572-3733) to review the beneficiary designations for your JRB retirement account and our complimentary term life insurance policy and update them if needed.
October 2022