Choosing the beneficiaries who will receive the assets of your estate may seem like an easy and straight-forward decision. However, making certain that you leave the right assets to the right beneficiaries is critical to effective estate planning.
The first step in choosing beneficiaries is to answer these three key questions:
- Who should receive assets from your estate? Would you want your spouse, children, grandchildren or a charity to be the beneficiary?
- Of those people/organizations, how much do you want each one to receive?
- What is the best way to transfer those assets to them?
How are assets designated to your beneficiaries?
Typically, your will gives instruction on how your assets should be distributed after death. The other method is through beneficiary designations. You can designate beneficiaries for retirement accounts (401k, IRA, etc.), life insurance, and annuities.
It is also important to take into consideration how the asset is owned. The title of an asset will dictate where it goes after death. For example, if your house is owned by you and your spouse as joint tenants with right of survivorship, when you die, your spouse will get that asset regardless of what your will might say.
What you should consider when naming beneficiaries:
Life Insurance. Once proof of death is established, proceeds from life insurance policies are paid to the beneficiary relatively quickly. If the beneficiary happens to be a minor child and a guardian has not been named or the proceeds have not been placed in trust, the state may assign someone to manage the proceeds on the child’s behalf.
Retirement Plans. Choosing the right beneficiaries of your retirement plans can have major tax implications. The younger the recipient the longer they have to withdraw the money from the plans. In the meantime, the account can continue to grow tax-deferred. For example, a person who is 55 years old has a shorter life expectancy and must withdraw funds at a faster rate than a person who is 20.
Also, if a charitable organization is part of your intent, it is advisable to name the organization as one of the beneficiaries. The reason is that the charitable organization won’t have to pay income tax on the distribution from these accounts and individuals will, resulting in lower overall taxes.
Trust as a beneficiary. Creating a trust allows you to determine how and when your beneficiaries will receive your estate after death. For example, you could create a trust that distributes income and principal (if needed) to a surviving spouse. Any principal remaining after the surviving spouse’s death can be distributed per your original intentions. This works well in a blended family situation.
Common mistakes when designating beneficiaries.
Remember to coordinate your beneficiary designations. Who you indicate as a beneficiary will override what your will says. For example, if your children are named as primary beneficiaries on your IRA, but the will says to give the IRA to your spouse, the beneficiary designation will supersede the will. The children will receive the IRA instead of the spouse.
Keep your beneficiary designation updated. If your children are names as beneficiaries and one of them dies, it is possible that their share will be allocated back to the surviving children instead of being passed to the grandchildren. Updating beneficiaries at significant life events can be critical!
Choosing the right beneficiaries for the right assets can be complicated, so consider consulting with your financial advisor and attorney. Making the right choices now will have a positive effect on your beneficiaries long after you are gone.
