Reviewing your beneficiary designations is one of the most important parts of estate planning – but it’s often overlooked. Outdated beneficiaries can unintentionally send your retirement accounts, life insurance, or investment assets to the wrong people. It happens more often than you think.
Every year, we send our clients a letter showing the beneficiaries listed on each of their financial accounts managed by our firm. It takes some time for us to gather the information and double check for accuracy – but it ends up being one of the most impactful things we do that bring our clients peace of mind. Not because we end up making a lot of changes, but because doing this reminds the clients that their wishes will be honored and their loved ones will be OK.
If beneficiaries are not regularly reviewed, you can end up in a situation where your money ends up in the wrong hands.
Picture this example about Ted:
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Ted has a significant amount of his wealth in IRAs and taxable brokerage accounts. He’s been divorced and later remarried but never updated his beneficiaries. When he passes away, his IRA and investment account will go to the named beneficiaries on his accounts.
The problem is that his ex-wife is still named as his sole beneficiary. He wants his new spouse Lisa to inherit his wealth… but he never added her as the beneficiary on his account.
If Ted realizes this and updates his beneficiary, all is well. If, however, he passes away before updating his beneficiaries…
Chaos ensues.
In today’s post, I’ll share:
Why beneficiary designations are critical to your estate planning
Which accounts need to be reviewed
Questions to ask during your beneficiary review
Beneficiary Designations and Your Estate Plan
Having the right beneficiaries named on your financial accounts is a critical part of your estate plan. It ensures your assets held in financial accounts are passed down to your loved ones or favorite charities.
Fulfilling Your Legacy Goals
When you pass away, your money will be distributed to your named beneficiaries. By naming beneficiaries, you maintain control over who ends up receiving your money after death. Designating a beneficiary also allows you to avoid probate, maintain privacy (unlike a will), and be intentional about how your inherited funds will be taxed.
Some people misunderstand how beneficiary designations work with your will and trust. Assets with valid beneficiary designations will take precedence over wills and trusts in most cases. Making changes to your beneficiaries in your will and trust is typically not enough to cover all your financial accounts – that’s where updating your beneficiary designations come into play.
Avoiding Probate
Having beneficiaries correctly named on your accounts allows you to avoid the probate process. If you don’t have any living beneficiaries named, your financial assets will go through probate. During probate, the court oversees the process of distributing your assets according to your will or state law. It can be time-consuming and expensive, and most people would prefer to avoid it.
During your review, you’ll want to replace any deceased beneficiaries named. If you pass away with only a deceased beneficiary named and no contingent beneficiary, your account may still go through the probate process.
Tax Planning Implications
Taxes play a significant role in determining your beneficiaries on financial accounts.
Retirement accounts, such as your IRA, have unique tax rules for beneficiaries. If your IRA is yet to be taxed, your beneficiaries will end up paying a tax bill on withdrawals from the inherited IRA at their ordinary income tax rate.
Think about what tax bracket your beneficiaries are in. Poor tax planning when designating beneficiaries can mean your heirs end up paying more in taxes, reducing the money left for them.
Example: Debra lists two beneficiaries on both her IRA and taxable account, split evenly. The first is her daughter Janice. The second is Humane Society of the United States, since she loves animals. Both the IRA and taxable account are equal in value.
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Her daughter Janice is a higher-earner and pays taxes at the highest federal and state rates. The Humane Society is a non-profit organization. Charities generally do not pay income taxes on inherited IRA assets and therefore receive the full value of the account.
When Janice inherits her share of the IRA, she will be on the hook for taxes upon each withdrawal. At the highest tax rates, her inheritance net of taxes may be significantly less than what she originally inherited.
Instead of naming both Janice and Humane Society equally on both accounts, Debra can be intentional about her beneficiary designations for the sake of tax efficiency.
One way to do this is to name Janice as the sole beneficiary of the taxable account, which receives a step-up in cost basis upon the owner’s death. Then name US Humane Society as the sole beneficiary of the IRA.
The amount each beneficiary inherits is the same. The difference is in how much they each keep net of taxes.
Primary vs. Contingent Beneficiaries
This is another important nuance when deciding your beneficiaries.
Your primary beneficiary is the first in line to inherit your assets. You can have multiple primary beneficiaries, each receiving a specified amount of inheritance.
You can also name contingent beneficiaries. These people will only receive an inheritance if there are no primary beneficiaries living or willing to accept the money.
If your primary beneficiary is already deceased when you pass away, your assets may be forced into probate if there is no living contingent beneficiary listed. Naming a contingent beneficiary makes it more likely that you avoid probate and have control over who your assets are given to.
Which Accounts Need a Beneficiary Review?
There are a few types of accounts that should be part of your beneficiary review.
Retirement Accounts
IRAs (Traditional, Roth, Rollover, SEP, Simple)
401(k) / 403(b) / 457 plans
Pension plans
Investment & Bank Accounts
Transfer on Death accounts (TOD)
Payable on Death accounts (POD)
Insurance Policies
Life insurance
Annuities
Health & Education Accounts
Health Savings Accounts (HSA)
529 College Education Savings Plan
Some of your assets will pass to your heirs based on account titling or instructions from your trust instead of beneficiary designations. These include joint investment or bank accounts and accounts titled under your trust.
To see who your current beneficiaries are, view your account online, check your latest statement, or call the custodian/insurance company and ask.
Questions to Ask During Your Beneficiary Review
Are my beneficiaries still living?
Are the percentages correct?
Are contingent beneficiaries listed?
Is there a way to make this more tax-efficient for me or my heirs?
Does this still reflect my wishes?
Does this coordinate with my estate plan?
In Summary
Reviewing your beneficiaries is one of the most overlooked parts of estate planning. In my view, it’s an exercise that should be done at least once every year or after a major life event occurs. Most people aren’t excited about this – it can be gloomy to think about what happens after we’re gone.
Investment advisory services offered through Andrews Advisory Associates LLC, a registered investment advisor. This blog is not meant to give investment advice. Before investing in any advisory product please carefully read any disclosure documents, including without limitation, the firm’s Form ADVs. The information herein is provided for informational purposes only, and does not constitute an offer, solicitation or recommendation to sell or an offer to buy securities, investment products or investment advisory services. Nothing contained herein constitutes financial, legal, tax, or other advice. These opinions may not fit your financial status, risk and return profile or preferences. Investment recommendations may change, and readers are urged to check with their investment adviser before making any investment decisions.
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