Designating beneficiaries is a loving and thoughtful way of caring for your loved ones in the event of your death. Without beneficiary designations on your life insurance policies, retirement assets, and many other accounts, these assets will pass through probate, a cumbersome process that results in high tax bills.
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We’re not attorneys or legal experts, but we want to share some helpful information that we’ve learned from those who are. In this post, we’re explaining why designating beneficiaries is important and the six common mistakes not to make when designating beneficiaries. Keep in mind that wills, trust, and estate laws vary from state to state and sometimes even from year to year, so always check with a local estate planning attorney to learn the best way for you to designate beneficiaries.
Why Designating a Beneficiary is Important
Designating beneficiaries serves several purposes. First, by naming beneficiaries on each of your assets, you can make sure your assets go where you want them to. When you designate a beneficiary, you clearly state how you want your estate broken up and who should get things. Second, it’s helpful for your family to know your intentions. It makes a difficult time a bit easier when your loved ones don’t have to think about how to split up your assets.
Common Mistakes People Make When Designating a Beneficiary
But designating beneficiaries isn’t as straightforward as you might think. People make several common mistakes when going through the process—mistakes you’ll want to avoid.
Mistake #1: Not Naming a Beneficiary for All Accounts
Beneficiaries are needed for all life insurance policies, retirement, and non-retirement accounts. Some people forget to designate a beneficiary on every account, or they believe it will be too much paperwork so they put it off.
The company holding your account has rules in place if you don’t list a beneficiary. For life insurance, the benefit is usually paid to the probate estate. Retirement and non-retirement assets usually go to the spouse if the person was married, and if not, to the probate estate. It’s important to avoid probate since it can result in your loved ones having to pay higher taxes.
Mistake #2: Forgetting to Name a Contingent Beneficiary on All Accounts
It’s important to not only provide a primary beneficiary but also a secondary one. If your primary beneficiary passes away first and no contingent beneficiary is named, it’s the same as having no beneficiary.
Naming a contingent beneficiary may also give your primary beneficiary the option to pass some assets to the secondary person named. Someone might do this to share your gift if they don’t need the money or want to accept less due to tax implications.
Mistake #3: Not Reviewing and Updating Beneficiaries Regularly
Things change, so it’s important to make sure the beneficiaries are kept up-to-date. Changes like having a child, getting married, getting divorced, or experiencing the death of a beneficiary can all have an impact. How would you feel if you left out a child accidentally? Or if a portion of your estate goes to your ex-spouse because you neglected to take him or her off as the beneficiary of an account?
Doing an annual review of your beneficiary designations ensures your information is updated and your wishes will be followed.
Mistake #4: Not Using Specific Names or Naming the Wrong Beneficiary
It’s a good practice to use specific names when naming a beneficiary instead of referencing your relationship, such as children or parents. Many states won’t recognize stepchildren unless they are explicitly stated. Not being specific can also result in distant relatives that you don’t have a relationship with trying to gain a portion of your estate.
You also should check that the person’s full name is spelled out clearly. For example, if the person has Jr. after his name, you should include it to avoid any confusion. If the person has a common first name, be sure to include a middle name.
Mistake #5: Not Considering Special Circumstances
There are three situations that you will want to consider very carefully when designating a beneficiary. Your purpose in designating beneficiaries and providing an inheritance is to improve the well-being of your loved ones. So you’ll want to consider what will be best in each situation.
1. Designating a Beneficiary with Special Needs
Some people are eligible for government aid for a disability, and they are considered “special needs” from an estate-planning perspective. When you designate a beneficiary with special needs, they may be disqualified from this aid. This may put the person in a position where they must spend down the inheritance and reapply for aid to be able to qualify again. Be sure to consult with an estate planning attorney familiar with these matters.
2. Naming a Minor Child as a Beneficiary
When you name a minor child as a beneficiary, they generally get access at the age of 18 or 21. However, most children of that age have no experience with managing money so they may make poor decisions. This situation is best handled with a trust.
3. Naming Someone Unable to Manage Money
You’ll also want to consider if and how you designate a beneficiary with known financial problems. Again, your goal in providing the inheritance is to help your loved ones by improving their life with your gift, so you want to be sure they are set up for success. Again, you can stipulate how money should be dispersed through a trust.
Mistake #6: Inconsistency with Estate Planning Documents
Your estate planning documents should match your beneficiary designations. For example, if your will states that you want your spouse to get half of the estate, but your life insurance and retirement benefits show your child getting everything, this can cause a problem. In many states, the beneficiary designation will override your will.
While it takes some time to review all your assets and ensure that your beneficiaries are all designated properly and as you want them to be, it’s time worth spending. And knowing the common mistakes people often make will help you to better plan, enabling you to stay in control of your assets while caring for your loved ones.
Download a handy tip sheet summarizing these mistakes to print and reference in the future!
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