by Michael Napier
Tuesday, October 23, 2012
in Financial Planning
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This isn’t one of my most exciting financial planning topics, but could be one of the most important.
Frequently, I come across clients or prospective clients with outdated or blank beneficiary designations. Your guess is probably correct on how these situations come about: divorced spouses forgetting to take one another off, deceased spouses forgetting to update with new beneficiaries, etc. Without regular reviews of your beneficiary elections, money may be passed to people or organizations that you may not approve of……horror stories happen all of the time.
To avoid problems, it is recommended that you check your designations once a year and especially after a major life-changing event such as a birth, marriage, death, divorce, etc. You want to make sure your assets go where intended. Do not expect your bank or broker to tell you if something is not right with your beneficiary designation.
The first thing to know is how property is passed to heirs:
- Jointly owned property. This property would automatically pass to the surviving owner, bypassing the probate process. This is the most common titling of accounts in a marriage.
- Beneficiary designation. Assets such as life insurance policies, annuities, retirement plans, Payable on Death or Transfer on Death accounts pass directly to the named beneficiary and bypass probate.
- Trust. Trust property goes to the beneficiary of the trust, bypassing probate.
- Valid will. The first three options trump the will. Property transferred via a will goes through probate which can be a lengthy, expensive and public process.
- Verify correct spelling of beneficiary names and social security numbers.
- Name secondary or contingent beneficiaries in case your primary beneficiary passes away. Without a secondary beneficiary, the assets go to your estate and therefore through the probate process.
- Use percentages, not dollar amounts in your bequest. Asset values change over time and you may have one beneficiary who receives more or less than intended.
- Tell your beneficiaries that they have been named and let them know where the important documents are and the names of your advisors.
- Reevaluate beneficiary designations on retirement plans during a job change. Beneficiary designations on retirement plans don’t carry over when you roll a 401(k) to a new employer’s plan or to an IRA or when you convert a regular IRA to a Roth IRA.
- Don’t name minors as beneficiaries. A court will appoint a guardian to manage the funds until the child reaches the age of 18. And even then, the minor may not be mature enough to manage the funds. A disabled child could also lose government benefits with even the smallest inheritance. Consider a trust when you would like to leave assets to a minor.
- Don’t name your estate as beneficiary. The assets will go through the probate process and can be claimed by your creditors or your heirs’ creditors. This is especially important for retirement plans because when you die and the estate is named as beneficiary, the full amount of the plan must be paid out and taxed within five years. Individual beneficiaries, however, could stretch out the distributions and the taxes for a much longer period of time.