The Big Estate-Planning Goof You May Be Making
Your assets may go to the wrong people if your beneficiary designations are wrong
You may have made a giant estate planning mistake without even knowing it — forgetting to update the names of your beneficiaries for your employer-sponsored retirement plans, IRAs, life insurance policies, mutual funds, bank accounts, brokerage accounts, annuities and 529 college savings plans.
If your beneficiaries are out-of-date, when you die, your assets could go the wrong people — a former spouse, for example — no matter what your will says.
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You probably designated a beneficiary when you initially bought insurance or signed up for your retirement plans. And you likely filled out POD (payable on death) or TOD (transfer on death) certificates when opening your bank and investment accounts, effectively naming beneficiaries for them.
Why Your Designations May Be Wrong
But your life and wishes may have changed since then. That’s why it’s wise to periodically review all your beneficiary designations and amend any that are out-of-date. Some financial advisers suggest also naming secondary or contingent beneficiaries. If you don’t, and your primary beneficiary dies before you do, your assets will go to probate, which can be costly and time-consuming.
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“Beneficiary designations that are inconsistent with your will can wreak havoc on a well-structured estate plan,” said Helen Modly, a wealth manager and Executive Vice President at Focus Wealth Management in Middleburg, Va.
The havoc usually is generally unintentional — but not always. “I’ve seen children get themselves named as beneficiaries on their parents’ accounts, thereby invalidating the parents’ will and effectively disinheriting their siblings,” said Modly.
Taxes and Your Beneficiaries
Naming beneficiaries for your IRA can be a smart tax-saving move, too. Doing so lets your heirs stretch out their withdrawals from the IRA over the rest of their lives, deferring income taxes on them.
By contrast, if you didn’t name beneficiaries in your IRA, your heirs noted in your will must withdraw — and pay taxes on — all the money in that retirement account within five years.
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6 Reasons to Update Designations
Here are six reasons you might need to update your beneficiary designations:
1. You got divorced or remarried. Some states automatically eliminate former spouses as beneficiaries; others don’t. Check with an estate-planning attorney to find out the law in your state.
“I had one client receive $250,000 from an ex-husband who forgot to update his beneficiary designation,” said Modly. “That was great for her, but not so great for his other heirs.”
2. You changed jobs and rolled over your retirement plan. When you move money from your former employer's retirement plan into your new one or into an IRA, your beneficiaries lose any claim to those assets. So you’ll want to ensure they’re named as beneficiaries on the new account.
3. Your primary beneficiary died. In this case, you’ll absolutely need to update your designation. If you had also named a secondary beneficiary, he or she will move up to primary status, but you’ll now want to name a new secondary, just in case.
4. Your financial institution changed ownership. These days, when banks, brokerages or mutual funds merge, they sometimes drop the beneficiary designations for older accounts.
“I’ve seen merged banks simply toss out the beneficiary forms on accounts more than 10 or 15 years old,” said Modly.
5. You had a child or grandchild. One caution, here: Don’t designate a minor (a child under 18 or 21, depending on your state) as a beneficiary. If you do, the state will appoint a conservator of assets until the child comes of age.
Instead, if you want this child to inherit your financial assets, create a trust for his or her benefit and name the trust as the beneficiary. (This might cost around $1,000 or so.) That way you control the terms under which your child or grandchild has access to the funds.
6. Your beneficiary became disabled. In this case, you’ll need to amend the designation or risk jeopardizing the beneficiary’s eligibility for Social Security’s Supplemental Security Income (SSI) benefits. The SSI program provides income and Medicaid insurance to disabled people with less than $2,000 ($3,000 for a couple) in what are known as “countable resources.”
Set up a Special Needs Trust for the benefit of the disabled person and designate the trust as the beneficiary on your accounts.
Review Beneficiary Designations Routinely
Fact is, it’s a good idea to review your beneficiary designations every year or so, even if you don’t experience a major life change. You can often find forms from financial institutions online or can call the firms to order them; you may need your newly-chosen beneficiaries’ Social Security numbers to complete the forms.
A good time to review your beneficiaries is February — after you receive your 1099 tax forms from the financial institutions holding your assets. “Those forms usually include the contact information for the relevant financial institutions,” said Modly. “I tell my clients to call all of them. Think of it as a Valentine’s Day present to your heirs.”
Harper Willis is a freelance journalist whose work has appeared on Next Avenue, Thestreet.com and WSJ.com.