Why Naming Beneficiaries is a Key Part of Estate Planning
Some people find it unappealing to think about how their finances will be allocated once they’re gone. This might explain why some Americans delay estate planning.
In fact, according to Caring.com’s 2024 Wills and Estate Planning Study, fewer than one in three Americans have an estate plan in place. One of the simplest yet most important steps in estate planning is naming beneficiaries.
What is a Beneficiary?
A beneficiary is a person or organization, like a charity or trust. They are chosen to receive assets from financial accounts, insurance policies, or other holdings when the owner dies.
Beneficiaries can be assigned to different accounts. These include retirement plans like 401(k)s and IRAs. They can also be assigned to life insurance policies. In some states, they can be linked to certain real estate holdings through a transfer-on-death deed.
Primary vs. Contingent
When naming a beneficiary, you’ll typically choose between a primary and a contingent:
● Primary beneficiary: This is the first person or entity in line to receive the assets.
● Contingent beneficiary: This is the backup recipient. They receive the inheritance if the primary beneficiary cannot inherit due to death, unavailability, or refusal.
If the primary beneficiary accepts the assets, the contingent beneficiary receives nothing. If the primary beneficiary has died or refuses the inheritance, the assets go to the contingent beneficiary instead. Naming a contingent beneficiary can help prevent complications or delays in asset distribution.
Why Naming a Beneficiary is Important
Not choosing a beneficiary won’t make your assets disappear. However, it may cause delays and complications. Here are some important reasons to name beneficiaries:
● Avoids probate: If there is no named beneficiary, assets may go through probate. This legal process can take months or even years to finish. Probate makes sure debts and taxes are paid before giving assets to heirs. This happens according to a will, if there is one, or state laws if there isn’t a will.
● Prevents disputes: Clear beneficiary designations may help avoid conflicts among family members who might disagree about asset distribution. Named beneficiaries on accounts take priority over instructions in a will. This means the named beneficiary will get the asset, even if the will says something different.
● Access to funds: If there is no named beneficiary, heirs may have to wait for probate to finish before receiving their inheritance. Choosing beneficiaries can help ensure that money from accounts, like life insurance or retirement plans, can be accessed more efficiently. This can be beneficial when paying final expenses.
● Reduces costs: Probate isn’t free—legal fees and court costs can eat up 3% to 8% of an estate’s value, depending on factors such as estate size and complexity. By assigning beneficiaries, you can potentially minimize these costs, allowing more of your assets to go to your heirs.
Accounts That Allow Beneficiary Designations
Several types of accounts allow you to designate beneficiaries. When doing so, we believe it’s wise to name both primary and contingent. Common accounts that allow this include:
● Life insurance policies – Ensuring a payout to loved ones after your passing.
● Retirement accounts – Including 401(k)s, 403(b)s, and IRAs.
● Annuities – Investment products that provide income during your lifetime and may include a death benefit.
● Health savings accounts (HSAs) – Can be passed to heirs under certain conditions.
● Non-retirement bank and brokerage accounts – Some accounts can use a Transfer on Death (TOD) designation to pass assets outside of probate.
Can You Name Multiple?
Yes! Most financial institutions let you name several beneficiaries. You can also say what percentage of the assets each should get. For instance, if you have three children, you might divide a retirement account or life insurance payout equally among them. You can also designate charities or trusts.
If a beneficiary dies before you, their share usually goes to the other beneficiaries. However, you can change this by using a per stirpes designation. This designation allows their share to go to their descendants instead.
Who Should You Name as a Beneficiary?
Your choice of beneficiary is personal, but common selections include:
● Spouse or partner
● Adult children
● Other family members or close friends
● A trust – A useful tool if you want to control how assets are distributed over time, particularly for minor children or those who might not be financially responsible.
● A charitable organization – If you want to leave a legacy gift.
Certain restrictions apply. For example, minor children cannot directly inherit retirement accounts or life insurance payouts.
If you name a minor, the court may choose a custodian. This person will manage the funds until the minor reaches the legal age of inheritance. This age is typically 18, 19, or 21, depending on state law. Setting up a trust can help ensure assets are distributed according to your wishes.
If you are married, you may need your spouse's consent. This is important if you want to name someone else as a beneficiary on certain accounts. This is most common in community property states.
Special care should also be taken when leaving assets to someone with special needs, as an inheritance could affect their eligibility for government benefits. A special needs trust may be a better option in such cases.
How to Add or Change a Beneficiary
Updating beneficiaries are usually straightforward and can often be done online through your financial institution’s website. If not, you may need to fill out a form. This form typically requires the person's name, date of birth, Social Security number, and their relationship to you.
If you update your beneficiaries, let them know. This way, they can have a better understanding of their designation.
What Happens to Inherited Retirement Accounts?
If you leave behind a tax-advantaged retirement account like a 401(k) or IRA, your beneficiaries will likely need to consider tax implications when withdrawing funds. Here are their general options:
● Lump sum withdrawal – They receive the entire amount immediately, but this could lead to a large tax bill.
● 10-year rule – Most non-spouse heirs must withdraw all funds within 10 years, but they can decide when and how much to take out each year.
● Spousal transfer – A surviving spouse can roll over the account into their own IRA, allowing for continued tax-deferred growth.
Final Thoughts
Naming beneficiaries is an essential step in helping ensure your assets are distributed according to your wishes. Since beneficiary designations override wills and estate plans, it’s important to review them regularly—especially after major life events like marriage, divorce, the birth of a child, or the passing of a loved one. If you have complex estate planning needs, consulting an attorney or financial professional can help you make the best decisions for your legacy.
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Disclosure:
This material is provided as a courtesy and for educational purposes only. Please consult your investment professional, legal or tax advisor for specific information pertaining to your situation.
Advisory Services Network, LLC does not provide tax advice. The tax information contained herein is general and is not exhaustive by nature. Federal and state laws are complex and constantly changing. You should always consult your own legal or tax professional for information concerning your individual situation
