How Do Beneficiary Designations Work?

Beneficiary designations ensure the efficient transfer of assets after someone’s passing. Assets with designated beneficiaries are automatically passed to the named beneficiary, regardless of the instructions in the original will or trust document. This means they are excluded from the probate estate, resulting in reduced costs and time associated with settling the estate.

Inside Indiana Business’s recent article, “Who are your beneficiaries?” explains that because the new owner is determined without the guidance of a will document, assets with designated beneficiaries are excluded from the decedent’s probate estate. The fewer assets subject to probate, the less cost and time associated with settling the estate.

Many different types of assets transfer via beneficiary designation at the original owner’s death. These include retirement accounts (IRAs, Roth IRAs, 401(k)s, 403(b)s, 457(b)s, pensions, etc.), life insurance death benefits, and the residual value of annuities. Bank and brokerage accounts can also be payable on death (POD) or transferable on death (TOD) to a named beneficiary. POD and TOD designations bypass probate–like beneficiary designations.

The owners can name both primary and contingent beneficiaries. The primary beneficiary is the first in line to inherit the asset. However, if the primary beneficiary predeceases the owner, the contingent beneficiary becomes the new owner. If there’s no contingent beneficiary listed, the asset transfers to the owner’s estate for distribution. There’s no restriction on the number of beneficiaries who can inherit an asset.

Charities can also be beneficiaries of assets. Because a charity doesn’t pay income tax, leaving a taxable retirement account or annuity to a charity will let 100% of the value go toward the charity’s mission. When an individual inherits, income tax may be due when the funds are distributed.

A trust can also be named beneficiary of an asset. This strategy is often employed when minors or those with disabilities are beneficiaries. Designating a trust as a beneficiary can be complex, so do so with the advice of an experienced estate planning attorney.

Simply naming an estate as a beneficiary is typically not a good strategy because this will subject the asset to probate, which can result in unfavorable income tax outcomes for retirement accounts.

When no beneficiaries are named, the owner’s estate will likely become the default, which leads to probate.

Take time to review your current beneficiary designations to be sure they reflect current wishes. Review these designations every five years or when life circumstances change (marriage, birth, divorce, death).

Whenever you name or change a beneficiary, verify that the account custodian or insurance company correctly recorded the information because errors are problematic, if not impossible, to correct after your death.

STEPS TO TAKE WITH BENEFICIARY DESIGNATIONS

1. Identify all accounts with beneficiary designations
2. Obtain copies of existing designations
3. Ensure accuracy of personal details (name, address, contact information)
4. Verify Social Security number or other identification details
5. Assess current beneficiaries
6. Determine if existing beneficiaries are still appropriate
7. Consider any changes in personal circumstances (marriage, divorce, birth, death)
8. Evaluate potential tax implications
9. Consider contingent beneficiaries
10. Determine if contingent beneficiaries are necessary
11. Select appropriate contingent beneficiaries
12. Consult legal and financial professionals, if necessary  — in some instances having a beneficiary designation may not work with your estate plan; check with your advisor.. 
13. Seek advice on complex or high-value assets
14. Understand any legal requirements or restrictions
15. Obtain necessary forms or documents from financial institutions
16. Complete and submit updated beneficiary designations
17. Maintain copies of updated beneficiary designations
18. Keep a record of dates and methods of submission
19. Regularly review and update
20. Establish a periodic review schedule (annually or biennially)
21. Stay informed about changes in personal circumstances or laws.