Designating beneficiaries for your accounts can be uncomfortable. You might feel like you’re playing favorites with your loved ones, or maybe neglecting them in some cases. But avoiding the issue could result in a bigger problem—if something happens to you, your assets could go to someone you didn’t intend.
Following are 7 common mistakes when making beneficiary designations, plus a strategy to potentially transfer your wealth more effectively.
Before you start determining what and how much you want to go to your beneficiaries, you’ll need a list of all the assets that make up your estate. Be sure to include the following:
Once you have a comprehensive list of your assets, do you know where you want them to go after you pass? The answer might be to your spouse, your children or grandchildren, your go-to charities or a combination of the above.
You’ll also want to consider whether you’d like to provide for outright distributions to the beneficiaries or, for larger inheritances, leave funds in a trust to provide for access to the assets over time.
Many people might think a will is the primary way for determining how someone’s assets are passed on. However, for assets which can be transferred using a beneficiary designation, that designation will decide who receives that asset upon your death regardless of what is stated in your will.
Failing to designate a beneficiary can be a costly mistake. Consider your retirement account: if you haven’t named a beneficiary, the account could get passed to your estate. If this happens, your heirs could be required to take distributions, which would be taxable to the recipient. However, if you’ve named your spouse as the beneficiary, they would have the option to roll over funds in a way that defers or minimizes taxes. If you’re charitably inclined, naming a charity as a beneficiary of a retirement plan can also be a good tax saving strategy.
Even if you’ve chosen a primary beneficiary for your main accounts, you may want to consider adding a secondary beneficiary in case the primary is not available or declines the inheritance.
With estate planning, it can be tempting to “set it and forget it.” But different life events might call for a review of your beneficiaries, such as becoming a grandparent or getting a divorce. For example, if one of your beneficiaries dies before you and the designation is never updated, your assets might become part of your estate and may have to go through the legal process called probate. The probate process may mean extra time and additional costs which could have easily been avoided with an updated beneficiary designation.
Some plans may automatically name your spouse or child as a beneficiary, but you should not rely on any default provisions in your plan. Make sure your designations are current and accurately reflect your wishes, and recheck them annually. Financial institutions and plan administrators are not responsible for your beneficiary designations.
Your plan can be affected by external factors, too. Major changes at the institution administering your retirement accounts or insurance policies – such as a merger or migration to a new system – could affect your designations, which can be lost over time or corporate/plan transitions. Request copies of your plan documents and periodically verify that the documents have matching information and are up to date.
Receiving an inheritance can occasionally have a negative impact on a beneficiary’s finances. The ability of a beneficiary to handle an influx of money should also be a consideration. For example, naming a young adult child who is not prepared to manage a windfall might result in some unwise short-term decisions which could reduce the lifespan of the inheritance.
Fortunately, there are some tools that can help guide your estate planning and transfer of assets. For example, a trust can help your assets avoid the probate process and give you control over how they’re distributed. You can name a trust as a direct beneficiary, then your assets transfer to the trust and distributions can be made from the trust to its beneficiaries according to your wishes.
Whether you leverage a trust or other estate planning strategy, work with a financial professional to make sure your priorities are being met in an effective way for you and your beneficiaries.