You’ve worked hard all your life, you’ve managed to accumulate assets, and you want to spread the wealth. However, if you don’t get the beneficiary designation piece of the equation right, your good intentions may fall by the wayside, far from what you or your heirs want.
There are some common mistakes that are made when it comes to naming that special someone who will take over your possessions. Here are the roads you don’t want to travel.
Don’t set it and forget it
"Unfortunately, unless you’re consistently diligent, change can lead to highly undesirable consequences for intended beneficiaries," warns Thomas Walsh, a client service associate at Palisades Hudson Financial Group.
For example, if you don’t keep up with life changes, you could exclude a child from, or even award an ex-spouse with your life savings, he says. To prevent this from happening, stay organize and revisit your account beneficiaries after major events, like marriage, divorce, birth of a child, death of a relative, disability of a loved one. "To ensure you don’t fall victim to this mistake, keep a copy of your most recent beneficiary designations forms for any life insurance policies and retirement accounts in a central location. Review them periodically to make sure the person or persons you intend to receive these assets upon your death is the person or persons on the form."
Surprisingly, says Ken Moraif, founder and senior advisor at Money Matters, "Seventy percent of beneficiary designations I see are out of date."
One is not enough
You’re patting yourself on the back because you named a beneficiary. For sure, one of the biggest mistakes you can make is not naming anyone, because then your estate becomes beneficiary by default, "This can create adverse tax and creditor issues," cautions Michael Fliegelman, founder and president of Strategic Wealth Advisors Network.
But before you relax, having just one beneficiary isn’t enough. You need a contingent beneficiary, the person or charitable organization next in line to inherit assets should the primary beneficiary predecease the owner of the account or insurance policy. While most people can correct beneficiary designations after the unexpected death of a primary beneficiary, it’s the scenario of a common disaster that poses the most risk. "If mom and dad perish in an automobile accident, it’s important to have someone next in line, for example, their children, to inherit the assets," says Michael Bukowski, a certified financial planner with RMB Wealth Advisors.
Be clear about TOD or POD
Transfer on Death or Payable on Death designations are available for bank and brokerage accounts. They allow an account owner to name a specific beneficiary to inherit the assets upon their death. While this can be an important planning tool, "it often unknowingly disinherits other beneficiaries," says Bukowski.
How so? Take an elderly woman who has two daughters as equal beneficiaries of her estate per the instructions in her will. Several years before her passing, she opens an account and a bank teller mistakenly tells her to name her sister as beneficiary through a Transfer, or Payable on Death designation. "Unbeknownst to her, she has just disinherited her two daughters with regard to the assets in that account," says Bukowski.
Choosing a minor
Naming a minor child as a beneficiary of a life insurance policy is a mistake. In many states, naming a minor as the beneficiary of a life insurance policy, either directly or indirectly, because the policy was subject to probate, will subject the life insurance proceeds to a court ordered guardianship of the estate for the minor child, says Mike Kilbourn, president of Kilbourn Associates. Thousands of dollars will be wasted in court and attorney fees due to the guardianship procedure and accountings that must be provided to the court, he says.
The solution? "Leave the proceeds in an insurance trust for the benefit of the minor child. This would allow the grantor of the trust to design how the policy proceeds are used and at what age the beneficiary has access to the proceeds – without court supervision," says Kilbourn.
Be mindful of divvying up the pot
For varying reasons, an account owner with multiple beneficiaries that he wants to treat equally may think it’s a good idea to leave one account to one child and a separate account of equal value to the other. "Often overlooked is the understanding that two accounts with equal balances, may not be treated the same for tax purposes," points out Walsh. The type of retirement account must be considered to truly leave equal amounts to your children.
For example, you may own a traditional IRA, as well as a Roth IRA with the same account values. Since these are both retirement accounts, you may decide to leave one to each child. Unintentionally though, this strategy may leave the beneficiary of the Roth IRA with as much as 50% more than the beneficiary of the traditional IRA, depending on the beneficiaries’ income tax brackets and the state they reside in, says Walsh. Withdrawals from the Roth IRA may be taken tax free, but withdrawals from the traditional IRA will be taxable as ordinary income, likely resulting in a lower inheritance for the beneficiary of this account.
A beneficiary form trumps your will
"A lot of people don’t realize that the beneficiary form overrides your will," says Henry Ramirez, an attorney and financial advisor with Wescott.
Say you intended to leave all your assets to your spouse in your will, but your IRA beneficiary form still names your first spouse, the IRA will go to your first spouse, "to the dismay or disgust of your existing spouse," says Ramirez.
Simply put, says Dale Terwedo, an advisor with Terwedo Financial Services, "A will is not the end-all, be-all of your estate plan. In reality, the money in your investment accounts is first distributed out to the beneficiaries listed on them before even reaching your will. Be sure both your beneficiaries and wills match up and support your estate plan."
Get your numbers straight
Designating a specific amount on the beneficiary form may cause the inheritance to fail, warns Ramirez. Things can go very wrong. Say you have stated that Joe Smith should get $50,000. If there is not enough money in the respective account to fund the designated amount, Joe Smith gets nothing.
To avoid such drama, state a percentage of the account so that the beneficiary will receive something. "You can say that Joe Smith should get 50% of the account, not to exceed $50,000."