By: Bo Aylin 27 April 2021

You are starting a new job and it’s time to enroll in the company 401(k) plan.  As you fill out the forms, you come to the section for entering beneficiaries.  It is day one or two in your new role and you’re asked to think about what will happen with your money when you die – takes away a bit of the excitement.  You don't have a will in place and quickly jot down your brother’s name, moving on to the next part in the enrollment process.

Now you are married and about to have your first child.  You know you will need some life insurance once a family comes into the picture.  You decide to take out a term life policy that will provide your family with protection for the next 20 years.  As you complete the application, once again you are asked to identify beneficiaries to receive the proceeds if you should die while the policy is in force.  Obviously, your spouse should be listed first (primary beneficiary), but what about the next level – contingent beneficiaries?  You go with your best guess and jot down the words, “my child.” Bases covered?  Maybe – Maybe not.

We often complete these beneficiary designations without much thought.  After all, there are so many instances in which beneficiary designations are needed.  In addition to retirement plans and life insurance, there are IRAs, Roth IRAs, annuities, bank accounts (pay-on-death), Health Savings Accounts, Incentive Compensation (stock options) and more.

Write something down:

Don’t skip the opportunity to name a beneficiary on an account or insurance policy.  When no beneficiary is identified, usually it is the probate court that will determine where the asset goes.  This process adds unnecessary delays and legal costs.  Sometimes an account agreement will provide for a “default” beneficiary, but that may not align with your intent.

Don’t Rely on Your Will or Trust in place of Beneficiary Designations:

When you die leaving a life insurance policy, IRA or 401(k) account behind, the company administering the account/policy will not ask to see your will.  Instead, they will rely on the beneficiary information you have on file with the company.  Making sure you have an updated beneficiary designation will ensure your assets pass as intended.

Regularly Review your Beneficiaries:

Life brings changes, and changes such as marriage, a 2nd marriage or having children can greatly impact who or what you want on your accounts and insurance policies as beneficiaries.  There are cases in which an ex-spouse was not replaced with the new spouse as a direct beneficiary, raising legal questions and requiring court intervention.  If you are recently married, make sure to remove your “brother” or parent as a beneficiary, in favor of your spouse. 

Retirement Accounts and Taxes:

IRAs and retirement plans such as 401(k) and 403(b) accounts are typically “tax deferred” investments.  This means upon a distribution (withdrawal) from these accounts, income taxes will be due to the recipient.  As your wealth grows it will be important to consult with an estate attorney or tax advisor for direction on how to list beneficiaries on accounts.  While it may be as simple as listing a surviving spouse, if you have young children it is likely trusts would be established if there is no parent to oversee the inherited funds.  In such cases, it can be advisable to name a trust as a beneficiary.  In the case of a trust receiving IRA or 401(k) assets, the taxes may be due in lump sum.  * The issues involved with naming trusts as beneficiaries on IRAs and retirement plans are numerous – we’ll save them for a future newsletter.

When children are older and able to manage their finances, there may be good reason to name each child as a beneficiary.  Under the current tax rules, non-spouse beneficiaries will need to withdraw funds (and incur tax) before 10 years after the passing of the account owner.  For younger children, funds must be pulled from the retirement account within 10 years of reaching the age of majority (18 in most states).  There is no “schedule” by which the beneficiary must remove funds – monies can be withdrawn any time during the 10-year period, but retirement accounts will need to be fully depleted at the respective 10-year mark [Prior to the recent change in tax law introducing the 10-year rule, non-spouse beneficiaries and certain trusts could “stretch” inherited IRA distributions by taking out minimum annual withdrawals over the beneficiary’s remaining life expectancy as determined by IRS tables – this is no longer the case]

A surviving spouse has the option to receive retirement funds into his/her own “inherited IRA.”  There is no obligation to withdraw any funds unless or until subject to Required Minimum Distributions (RMDs), which for most spousal account holders begins at age 72.

What about leaving money to a Charity?

If your estate plan includes a provision for charitable organizations, it is usually advisable to name the charity or charities as a direct beneficiary(ies) on your IRA or retirement plan.  When a qualified charity receives funds from an IRA or 401(k), no income taxes are due.  If you should choose to name a beneficiary other than a spouse, such as a charity, your spouse will need to give consent to the administrator of your plan or account. 

What if I have a revocable living trust?

A revocable trust is an estate planning instrument that allows the creator of the trust to avoid a probate proceeding when the estate is settled.  In some cases, you may want to designate your revocable trust as a beneficiary on an account or policy.  When using a revocable living trust, many attorneys recommend naming the revocable trust as the 100% primary beneficiary on any life insurance policy.  Funds from a life insurance claim are not subject to income taxes (federal or state). 

Can I add a beneficiary to my bank or brokerage accounts?

In some situations, it may make sense to add a beneficiary to a bank or brokerage account.  For a simple estate, this can be part of a strategy to avoid probate.  Banks can usually provide a “Pay-on-Death” (POD) form which allows the account holder to name a beneficiary on the account.  Brokerage firms allow for TOD (Transfer-on-Death) accounts, which accomplishes the same objective.

The process of managing your beneficiary designations is straightforward.  Unlike amending or re-drafting a will or trust, it merely requires filling out a form and signing.  Yet forms can be confusing.  At PrairieView, we make it part of our procedures to periodically review beneficiaries with clients.  We all want our hard-earned financial resources to pass in the way we have planned.  It’s important not to overlook the all-important beneficiary designations.

Please be in touch if we can answer any questions on this and other financial planning/investment topics.  We always look forward to hearing from you.

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Bo Aylin

Partner
Chief Compliance Officer

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