The Right Beneficiary

Who have you designated to inherit your IRA, Annuity, Life Insurance policy or 401(k)?
A review may be in order.

Here’s a simple financial question: who is the beneficiary of your IRA? How about your 401(k), life insurance policy, or annuity? You may be able to answer such a question quickly and easily. Or you may be saying, “You know … I’m not totally sure.” Whatever your answer, it’s smart to periodically review your beneficiary designations. 7

Your choices may change with time. When did you open your first IRA? When did you buy your life insurance policy? Was it back in the eighties? Are you still living in the same home and working at the same job as you did back then? Have your priorities changed a bit – perhaps more than a bit?

While your beneficiary choices may seem obvious and rock-solid when you initially make them, time has a way of altering things. In a stretch of five or ten years, some major changes can occur in your life – and they may warrant changes in your beneficiary decisions. Not only that, as times change, who you have chosen as your beneficiary can be as important as how you choose to pass down those assets. 1,7

In fact, it may be wise to review your beneficiary decision annually. Why? Companies frequently change custodians for retirement plans and insurance policies. When a new custodian comes on board, a beneficiary designation can get lost in the paper shuffle. (It has happened.) If you don’t have a designated beneficiary on your 401(k), the assets may go to the “default” beneficiary when you pass away, which might throw a wrench into your estate planning.

It’s important to realize that the heirs you’ve designated in living trusts or wills can’t always take precedence over outdated beneficiary designations on your life insurance or retirement plans. Generally speaking, whoever you name on the most-recent beneficiary form will get your assets when you die even if your will or living trust designates a different heir. 7

Your choices affect your loved ones. The beneficiary of your IRA, annuity, 401(k) or life insurance policy may be your spouse, your child, maybe another loved one, or maybe even an institution. Naming a beneficiary helps to keep these assets out of probate when you pass away. Proceeds from a life insurance policy are typically paid out quickly (within days or weeks after proof of death) which means your beneficiaries will have the funds when they need them. In contrast, who you name as the beneficiary on an IRA or 401(k) can have important tax implications. It may be wise to consider setting up a trust to manage these assets, especially if the beneficiary is young.

Beneficiary designations commonly take priority over bequests made in a will or a living trust. For example, if you long ago named a son or daughter who is now estranged from you as the beneficiary of your life insurance policy, he or she is in line to receive the death benefit when you die, regardless of what your will states. Beneficiary designations allow life insurance proceeds to transfer automatically to heirs to avoid these assets going through probate. If one of your beneficiaries has pre-deceased you, the proceeds will automatically transfer to their designated heirs.1,2,6

Divorce and remarriage necessitates a conversation about estate planning. Beneficiary changes need to be considered carefully and in some cases, it may not be possible to remove an ex-spouse as the beneficiary of a retirement plan. 3,7


You may have even chosen the “smartest financial mind” in your family as your beneficiary, thinking that he or she has the knowledge to carry out your financial wishes in the event of your death. But what if this person passes away before you do? What if you change your mind about the way you want your assets distributed, and are unable to communicate your intentions in time? And what if he or she inherits tax problems as a result of receiving your assets?

Your choices affect your estate. Virtually any inheritance carries a tax consequence. (Of course, through careful estate planning, such as forming a trust, you can try to defer or even eliminate that consequence.) If you are simply naming your spouse as your beneficiary, the tax consequences are less thorny. Assets you inherit from your spouse aren’t subject to estate tax, as long as you are a U.S. citizen. And joint ownership with rights of survivorship makes it possible to pass rights of ownership on to a surviving spouse while avoiding probate. 1,2,4

When the beneficiary isn’t your spouse, things get a little more complicated for your estate, and for your beneficiary’s estate. The rules for passing on assets from an IRA, for example, can be complicated. If you name, for example, your child or your siblling as the beneficiary of your retirement plan assets, the amount of those assets will be included in the value of your taxable estate. (This might mean a higher estate tax bill for your heirs.) You’ll want to consider, for example, what will happen tax-wise when your young heir receives the required minimum distributions from your IRA. 5


And the problem will persist: when your non-spouse beneficiary inherits those retirement plan assets, those assets become part of his or her taxable estate, and his or her heirs might face higher estate taxes. Your non-spouse heir might also have to take required income distributions from that retirement plan someday, and pay the required taxes on that income. 5

If you designate a charity or other 501(c)(3) non-profit organization as a beneficiary, the assets involved can pass to the charity without being taxed, and your estate can qualify for a charitable deduction. 6

Are your beneficiary designations up to date? Don’t assume. Don’t guess. Make sure your assets are set to transfer to the people or institutions you have chosen.


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