Taking time to review your account beneficiaries can do more than just make sure your wishes are met, it can also save your loved ones a significant amount of hassle or surprise when you pass. While all these decisions should be discussed with an estate planning attorney, here are some common issues we’ve helped our clients avoid.
Why beneficiaries matter
Most retirement accounts are composed of tax-advantaged savings, such as pre-tax 401(k) or IRA funds, or Roth savings. As such, when the account owner dies, and a non-spouse inherits the funds, certain rules apply as to how the funds can be distributed. Often, someone who inherits the account must take out a specified, required minimum distribution each year. For pre-tax savings, that beneficiary must also pay tax on it. So correctly aligning your beneficiaries not only means the right people inherit your savings, but it also means that they receive the proper tax treatment.
Not naming any beneficiaries
Likely the biggest mistake you can make is not naming any beneficiaries at all. If this happens, your retirement account will flow through your estate, and it won’t be eligible for stretch distributions that occur over your beneficiary’s life expectancy. At a minimum, you want to have a beneficiary on the account other than your estate.
Not naming a contingent beneficiary
In many cases, the primary beneficiary on a retirement account is a spouse. But may folks stop there, not listing someone else in the event they’re pre-deceased by their primary beneficiary, or pass simultaneously. Keeping up-to-date contingent beneficiaries on your accounts spares your IRA or 401(k) from processing through your estate and losing its tax advantaged form.
Not updating beneficiaries
Another common error that crops up relates to beneficiary maintenance – ensuring that your beneficiaries match your wishes. Common instances include divorce, a new marriage, or the birth of a loved one. Reviewing your beneficiaries at these crucial life junctures is an important exercise.
Naming someone to ‘take care’ of the funds for a minor child
Many parents with minor children don’t want them to inherit retirement funds out-right, and rather list the child’s aunt or uncle, or grandparents as the primary beneficiaries on accounts. This is a can be a major mistake with adverse tax consequences.
Parent’s of minor children should consider listing a trust as the contingent beneficiary. That way they can control the assets and distribution requirements according to their wishes. It’s important to work with a qualified estate planning attorney and a financial advisor to establish the trust and ensure it cooperates with the required minimum distribution rules in the tax code.
Naming the ‘wrong’ beneficiaries
Finally, if you plan to leave a portion of your retirement savings to charity upon passing it’s important to make sure you’re leaving the charity the right type of accounts. For example, say you’ve amassed a sizeable IRA account, and even have a Roth you’ve funded over the years. One option to consider is leaving a portion of the IRA to charity, while earmarking the Roth funds for your other beneficiaries. With charities being tax-exempt, they don’t stand to benefit from tax-free Roth savings.
Any decision about beneficiaries should be made in consultation with your estate plan. Consider reviewing all your beneficiaries annually and whenever significant life changes occur.