We have seen many instances where, because beneficiary designations were not given the attention they deserved, the wrong person got the money. Beneficiary designations should make up a significant part of your estate planning and retirement planning process, don’t let them slip through the cracks.
What is a beneficiary designation?
Beneficiary designations are pretty simple; it is the person, persons, or organization you name to receive a specific asset after you die. Life insurance, annuities, 401ks, 403bs, and IRAs all have beneficiary designations.
A beneficiary can be one person, multiple persons, or even an organization, like a nonprofit that is special to you or your church. Most people are going to list their spouse, and then their children, but it can really include anyone you want.
You can designate the amount or percentage you would like each beneficiary to receive. With beneficiary designations, you can lay out exactly what you want to happen with your asset.
Why are beneficiary designations important?
Beneficiaries designations are important because they allow the assets to transfer directly to your heirs at your death. The money avoids probate and is able to get to them quickly and privately.
Probate is the legal process of distributing assets after death, it can be time consuming and expensive. After a person dies, their family needs money, usually very quickly. Beneficiary designations allow money to them as fast as possible.
Beneficiaries are able to get this money so quickly because it bypasses any Will or trust that has been set up. Beneficiary designations trump your Will. While this usually works out just fine, it can cause a lot of chaos when the beneficiary designations are out of date or wrong.
It is a common misconception that whatever is in the Will goes and that is going to apply to all the assets. This is not the case. For example, say you get a 401K from your workplace. When you sign up, you designate your current spouse as the beneficiary. In 10 years, you get divorced and get remarried to a new spouse. Even though your new spouse is named in your Will, if you do not change your beneficiary designation on your 401k, your ex-spouse will get that money.
Life changes happen constantly. Marriage, birth, death, adoption, and job change all require a look at your beneficiary designations. It is best practice to look at them every few years to make sure they are aligned with your wants.
What are Contingent Beneficiaries?
A contingent beneficiary is your “back-up”. It is who you want to get the specific asset if your primary beneficiary is not alive when you pass.
A contingent beneficiary has no status if the primary beneficiary is living when you die. The contingent beneficiary becomes the primary beneficiary you die and there is no living primary beneficiary.
This is just as important to keep updated as your primary beneficiary.
Being more specific: Per Stirpes vs Per Capita
What about if you have more than one primary beneficiary? It can get a little more complicated than just naming a contingent beneficiary if your primary beneficiary dies. That is why you can choose between the designations per stirpes and per capita.
“Per Stirpes” means the deceased primary beneficiary’s heirs will get paid. For example, say you name your two children as your primary beneficiaries. If one of them passes before you, their children or spouse will receive the payment that you intended for them.
“Per Capita” means the deceased primary beneficiary’s share will be divided among the living beneficiaries. In the above example, per capita means your living child would receive the entire amount and the deceased children’s heirs wouldn’t get anything.
We simplified the above examples, but these designations really give you the freedom to name exactly what you want to happen with your assets in multiple situations. With beneficiary designations, you can divide the money up anyway you want.
Getting your beneficiary’s tax-free money
The first step in retirement and estate planning is going to make sure your beneficiary designations are correct and updated. Once you’ve done that, you can take a few more steps to make sure these beneficiaries get the money tax free.
Leaving your beneficiaries taxable accounts, such as IRAs or 401ks, can leave them with a huge tax bomb. There are strategies you can put into place now to avoid this situation.
The two most common strategies are to roll the money in these taxable accounts into a Roth IRA or to use this taxable money to pay for life insurance. Both a Roth IRA and life insurance provide tax-free distributions and payments. If you want to learn more about how to leave your heirs with tax-free money, you can read about that here.
Beneficiary designations are very important, but they are not the only part of a well rounded estate plan. Similar to a Will, beneficiary designations are only going to take effect once you pass. They do not provide any protection in the case of incapacity. You need to make sure you have the 4 most important estate planning documents appropriately filled out for that. Figure it out now, and get the peace of mind that you and your heirs will be taken care of, no matter what happens.
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