April 24, 2023

Clean Up Beneficiary Designations to Avoid These Common Mistakes

In Wealth Strategy

Noel Sanchez
Contributions from: Noel Sanchez, CFP®

If you’re like most people, chances are the only time beneficiaries have crossed your mind was when you were opening some type of financial account, signing up for life insurance or contributing to a retirement account offered through your employer. Since these opportunities come up infrequently, we can all benefit from a regular review of the important people we have named as beneficiaries of our assets. Like cleaning out your closet, reviewing beneficiary designations may not be the most exciting task but the result is peace of mind that you are organized, and everything is in the right place.

Equally important is updating your beneficiary designations when your circumstances change. Typically, this follows a major life event, such as marriage, divorce, birth or the adoption of a child, death of a currently listed beneficiary, or diminishing mental capacity of a family member. Outside of these life changing events, we recommend that you review your beneficiaries at least every three years.

So, what should you look for when reviewing beneficiaries? First, ask yourself these questions:

  • Who am I responsible for that would suffer financially if I passed?
  • Are there any tax or estate planning considerations that would impact my choice of beneficiaries?
  • Should minor children or beneficiaries with special needs receive assets outright or via a trust?
  • Have my feelings or relationships with my beneficiaries changed since I last reviewed this document?
  • Did my estate planning attorney make specific recommendations for how to name my beneficiaries?

The answers to these questions will generally lead you to the optimal choice of beneficiaries. If you are uncertain how to answer any of these questions, ask your estate planning attorney as your beneficiary designations are a key piece of your overall estate plan.

Even with proper beneficiary guidance, here are the most common mistakes we’ve helped families resolve:

Mistake #1: Not realizing that some of your accounts allow for a beneficiary designation

There are several account types where naming a beneficiary is important but may not be obvious. Accounts that can Transfer on Death (TOD) or Pay on Death (POD) include life insurance policies, annuities, retirement accounts (IRA, Roth IRA, 401k, 403b, 457, etc.), bank accounts, and brokerage accounts. If you notice that one of these accounts is missing a named beneficiary, reach out to your financial institution to be sure that you have one listed. Often you can complete this online, while some institutions may require a signed physical form.

Mistake #2: Having no beneficiary or contingent beneficiary named

The easiest way to resolve this issue is to simply take a few minutes to consider and list the person you want to include as your primary beneficiary and your contingent beneficiary. If your primary beneficiary were to precede you in death, the assets would pass to the next person in line – your contingent beneficiary. If there is no beneficiary or contingent beneficiary named on the account at the time of your passing, your estate would become the default beneficiary. As a result, the account would be subject to probate. Probate is a legal process for distributing a deceased person’s property and settling their estate, and can be costly and time consuming, ultimately delaying the transfer of assets. The goal of naming a beneficiary is to have a smooth transition upon death to the correctly intended recipient and avoid the probate process.

Mistake #3: Believing that your will supersedes any beneficiary designation listed on your accounts

A common misconception is that your will is the ultimate directive on who should inherit your assets, but beneficiary designations actually supersede estate documents, such as a will. Consequently, those assets are contractually bound to be distributed to the beneficiaries listed at the account level, even if that’s different from what your will states. Therefore, making sure that your estate documents and your account beneficiary designations are in alignment is critical.

Mistake #4: Naming a beneficiary incorrectly

It goes without saying that you want to ensure the spelling of your beneficiary’s name is correct, but there is other key information that you may need to verify for accuracy, such as if there are multiple people in the family with a similar name, or if they have a suffix such as Jr., Sr. or III. Keep in mind that people often change names over time through divorce or marriage and this can lead to names not matching exactly, which could result in delayed payouts, or even litigation in the case of those with similar names.

Mistake #5: Overlooking special circumstances

Although well-intended, giving assets directly to certain loved ones may not always be the best course of action. This could be true in the case of minors, those with special needs, or those who lack the ability to manage assets or are facing creditor issues. Minors, for instance, are not legally competent and therefore cannot claim assets. In the absence of a legal guardian, such as a surviving parent or another trusted individual named in your will, a guardian must be appointed by the courts to manage the assets until the minor reaches the age of 18. However, guardianships can be expensive and require annual court accountings. People with special needs who receive assets directly may lose their government benefits, as the inheritance could disqualify them from eligibility. Meanwhile, those with financial issues or creditor problems may lose their assets due to mismanagement or debts. In such situations, a properly drafted will that creates a trust specific to that beneficiary’s need would best achieve your desire to benefit your loved one financially without these potential pitfalls. The trustee in charge of the trust can claim and manage the asset on behalf of the intended recipients, consider each situation, and ensure the assets are used as intended by you.

Keeping these common oversights in mind should help you to ensure that your financial account beneficiary designations are accurate and up to date. Once you check this off your list, you shouldn’t need to revisit for a few years, unless you experience a major life change. Reach out to your Coldstream wealth management team if you have any questions, would like to review your beneficiaries, or wish to discuss the distribution of your assets with an estate planning attorney.

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