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Having an outdated beneficiary designation could mean trouble

by Joseph Arroyo | Contributor
August 31, 2020

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Beneficiary designations are a simple but supremely important aspect of your retirement and estate plans. Reviewing and keeping your beneficiary designations up to date for accounts like 401(k), life insurance, annuities and other qualified accounts can keep your estate plan on track and avoid confusion, frustration and expense for your heirs.

What are beneficiary designations and how do they work?

A beneficiary designation is an official and legal selection of your beneficiary, or the person or entity that you want to receive certain assets in the event of your death. In the past, beneficiary designation was carried out by filling out paper forms. These days, however, most beneficiary designations are done electronically.

Essentially, a beneficiary designation names a specific person or people you want to receive the assets in your account when you die. You typically complete beneficiary designation forms for investment and savings accounts like:

  • Life insurance
  • Annuities
  • 401(k), 403(b) and other retirement plans
  • IRAs
  • After-tax investment and bank accounts

What are some potential problems with beneficiary designations?

Problems occur with beneficiary designations in mainly two ways:

  • Sometimes beneficiary designations are never made.
  • Sometimes beneficiary designations are not kept up to date with changes in your family status or estate planning goals.

In the broadest sense, when something goes wrong with a beneficiary designation, the “wrong” person ends up receiving the funds from your account or accounts. Examples of this can include:

  • A child instead of a grandchild
  • An ex-spouse instead of your children
  • Your spouse instead of a trust

There are many other outcomes. Basically, you want to use beneficiary designations to make sure that your savings go to the people you intend.

The consequences of mishandling beneficiary designations can range from minor, but embarrassing, to major and expensive:

Heavily used white eraser on orange pencil
  • Bad feelings or estrangement between relatives
  • Wasted money on legal challenges
  • Tax consequences
  • Benefit eligibility problems

Some of your heirs may expect to receive a specific inheritance, especially if you’ve discussed it with them in advance. If one or more of your beneficiary designations are incomplete or out of date, however, these wishes may not be realized, which can lead to disappointment, or worse.

There can also be tax consequences, especially if you have a non-spouse beneficiary of qualified retirement plan assets. Generally, when your spouse is your beneficiary, they have the option to roll the money over to another qualified account, like an IRA. This may help you delay, but not eliminate some taxes.

However, if someone other than your spouse is named your beneficiary, taxes may need to be paid sooner. When this is unexpected, it can cause a lot of stress for the person inheriting the assets. And, it could be avoided by simply making sure your spouse is the designated beneficiary.

On the other hand, you may not want certain assets to go to your spouse. If you were trying to limit or reduce his or her assets, perhaps to qualify for certain benefits, like Medicaid, it would be beneficial for your children or grandchildren to inherit an account rather than your spouse. A beneficiary designation listing a person with special needs could jeopardize that person’s ability to qualify for Supplemental Security Income and Medicaid.

Life insurance generally receives favorable tax treatment, but once again your beneficiary designation must be made so as to keep your estate planning goals on track. This can happen when you have an ex-spouse and are re-married. If you want your current spouse to receive your life insurance policy’s death benefit, be sure you’ve updated your beneficiary designation.

Default beneficiary terms and methods

When you don’t designate a beneficiary, or your designation is somehow invalid, the assets will still be inherited by someone, assuming that you have some surviving relatives. The question is how they will be split up.

There are two main default methods:

  • Per capita
  • Per stirpes

With per capita, your affected accounts are split up equally among your living surviving descendants. If a child predeceases you, your surviving children will inherit a larger percentage. With this distribution method, grandchildren are not recipients.

On the other hand, per stirpes takes into account the possibility of one of your children not surviving you. In this case, your deceased child’s children would split their parent’s share of inheritance. While this dilutes what your surviving children will receive, it does allow your grandchildren to receive their deceased parent’s inheritance by proxy.

It’s important to note that per capita and per stirpes inheritance methods exclude your spouse. So, if you have investment accounts that predate your marriage and don’t name a beneficiary at all, your spouse could end up being bypassed in the disposition of your estate.

A spouse must consent to removal as beneficiary

Certain qualified retirement plans like 401(k), pension plans and money purchase plans require a married participant to designate a spouse as the beneficiary. If you wish to make a non-spouse beneficiary, or change from a spousal to non-spousal beneficiary, the spouse’s notarized consent is needed. This is also true for IRAs in many states.

This issue is particularly relevant when two spouses are separated, but not officially divorced. Until the named-beneficiary spouse consents to giving up beneficiary status, or a divorce occurs, they will remain the beneficiary of any qualified retirement plan accounts. During a divorce, these assets are split up through a Qualified Domestic Relations Order (QDRO). After the QDRO has occurred, you can name a new beneficiary.

Keep your retirement and estate plans in mind and update beneficiary designations

These days it’s pretty rare to find that no beneficiary is designated. However, beneficiary designations frequently become invalid or out of compliance with your goals. For this reason, it’s important to periodically review all of your beneficiary designations.

During your review, you can work with your tax, retirement and estate professionals to be sure that your designations are capable of facilitating the plans you’ve made. If anything is amiss, take the time to resolve it right away. Doing this will ensure that your plans and wishes are honored, and that you limit or eliminate any potential for hard feelings between your heirs.

Alliance America can help

Alliance America is an insurance and financial services company. Our financial professionals can assist you in maximizing your retirement resources and achieving your future goals. We have access to an array of products and services, all focused on helping you enjoy the retirement lifestyle you want and deserve. You can request a no-cost, no-obligation consultation by calling (833) 219-6884 today.

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