Beneficiary Bungle

Designating beneficiaries for your retirement accounts and life insurance policies is one of the most critical decisions you can make in the estate-planning process.  Yet, for some reason, many people put very little (if any) thought into the decision.  People spend decades accumulating assets and watching their spending, with the hopes of passing on an estate/legacy to the next generation, but then fail to spend the necessary time and energy to make sure their beneficiaries are correct for their specific situation and goals.  As a financial planner, it is deeply disheartening to see people do such a diligent job of savings and accumulating assets, only to see some or all of these assets squandered by poor planning when it comes to the final distribution of these assets.

With that in mind, below is my list of the five most common mistakes I see in designating beneficiaries on retirement accounts and life insurance policies.  Of course, every situation requires its own evaluation and solution, and all estate-planning matters should be discussed and confirmed with a qualified attorney, before making any changes.

 

1. No Named Primary Beneficiary

It may seem too obvious to warrant mentioning, but this happens far too often.  By failing to name a primary beneficiary, you are in essence turning over the job to the state.  And, guess what? In all likelihood, the state is going to make you pay (in both time and money) for the privilege of distributing your assets.  If you die without naming a beneficiary for some or all of your assets/property, these assets go through a process called “Probate”.  What this means is that the state will decide who is to get your assets.  And, to make matters worse, Probate Is a very public and often costly process.  There are very few times when Probate is the desired outcome, and this is something that could have been easily avoided by simply designating the proper beneficiaries for your retirement accounts and life insurance policies.

 

2. No Named Contingent Beneficiary

Naming one beneficiary is usually not enough.  Sure, it is better than none (as discussed above), but there is still work to be done.  If you have only named a primary beneficiary, and that person happens to pre-decease you, you are back to having no named beneficiary.  And, as we already know, that is not good.

People often set-up up their beneficiary designations for the first time while they are still relatively young.  They may name their spouse, or a friend, as their primary beneficiary, and this may seem like enough, as they are young and believe they will have plenty of time to update/change their beneficiaries as needed in the future.  (We are all immortal when we are young, right?!?!)  The problem is, in reality, you never know exactly when your beneficiary designation will come into play.  That is the whole point of naming a beneficiary in advance, is that we don’t know when we will die. 

The best practice, therefore, is to name one or more “contingent beneficiaries” in addition to your primary beneficiary or beneficiaries.  These are beneficiaries who will be next in-line to receive your property if your original beneficiary has already passed away.  And, for those of you who want to be extra-extra cautious, you can even add a third set, or “tertiary”, beneficiary to your designations.  (And, yes, it can be your pet. Just remember to have also named a “custodian” to manage these assets for Fluffy’s best interests.)

 

3. Failing to Update Beneficiaries

Naming beneficiaries on your retirement accounts and life insurance policies should not be a “set-it-and-forget-it” process.    Your beneficiary designations should be reviewed and updated regularly to reflect changes in your personal situation or financial objectives.  Any of the following could affect your beneficiary designation strategy; marriage, divorce, birth, death, relocation to another state, change in citizenship status, inheritance, substantial growth of assets, or changes in federal and/or state laws. 

There have been numerous times when I have seen this in action.  First, there is the second (or third…) marriage situation, where one spouse never got around to making a change, and still has their ex-spouse listed as their beneficiary.  (Talk about causing havoc from the grave!)  Or, even more common, is the situation where people add their child as their beneficiary, or contingent beneficiary, after their first child is born.  However, when the next child comes around, they fail to add him/her as a beneficiary.  (We all want our children to get along and support each other after we have gone.  This is not the way to make it happen!)

 

4. Using “Pro-Rata” instead of “Per-Stirpes” (Or, vice-versa) -

How many people know the difference between “Pro-Rata” and “Per-Stirpes” in regard to naming beneficiaries?  The answer is, almost no one.  However, the difference is both stark and ultimately important.  To help illustrate the point, let’s assume you have named your two kids as 50/50 beneficiaries (or contingent beneficiaries) of your IRA.

  • “Pro-Rata” means that if either of the kids were to pre-decease you, when you die, the money that would have gone to the now-deceased child, will all go to your remaining surviving child.
  • “Per-Stirpes” means that if either of the kids were to pre-decease you, when you die, the money that would have gone to the now-deceased child, will all go to that child’s beneficiaries (most likely their spouse and/or children).

In general, the default election in most circumstances is to the Pro-Rata designation.  And, in many situations, this may be the correct designation to use.  However, once there are grandchildren or great-grandchildren in the equation, many people would prefer the Per-Stirpes form, so that the future generations are looked after.  However, without a proactive switch from Pro-Rata to Per-Stirpes (or the other way around), this does not occur. 

 

5. Updating Wills or Trusts, But Not Updating Beneficiary Designations -

Many people have the misplaced belief that if/when they update their wills or trusts, and change their beneficiaries on these documents, that this will also change the beneficiaries on their retirement plans and life insurance policies.  This is absolutely not the case.  These are separate and distinct processes that must be dealt with as such. 

When you die, naming the beneficiaries in your will or in your trust has no bearing on how your retirement assets and life insurance proceeds are distributed.  Retirement accounts and life insurance policies have named beneficiary designations, and these designations supersede what is written in your will and/or trust.  That is why estate planning should be done in a comprehensive and well-thought-out manner, and almost always with the help of a qualified attorney.  It is crucial that your beneficiary designations are working in conjunction with your other estate planning documents (will, trusts, etc.), in order to ensure the ultimate outcome you have envisioned.

 

Please take the time to designate your beneficiaries correctly.  This is one of the most important things you can do to protect your legacy and your loved ones.  This is not a simple one-time process, but an ongoing and ever evolving one.  No one know when they will die, but at least you can (and should) be sure where your assets will go when you do.