Estate Planning Series: Why The Beneficiary Designation Is So Powerful

Your estate plan likely has many moving pieces — wills, trusts, power of attorneys, and more. With everything going on, it's easy to lose sight of one of the most powerful tools in your bag: the beneficiary designation. On the surface, beneficiary designations may seem small and inconsequential, but they pack an intense punch. Here's why your beneficiary designations matter so much.

What Is a Beneficiary?

A beneficiary is a person or entity that receives an asset from someone else. You name beneficiaries on all sorts of financial documents: life insurance, retirement accounts, real estate, and even bank accounts. Your beneficiary designation denotes where you want your assets to go after you pass away. This could be your children, grandchildren, another family member, a trust, a charitable institution (for those that are charitably inclined), etc. Most accounts (or policies) allow you to name a primary and a contingent beneficiary. It’s often best to do both! Think of the primary as your top choice(s) and the contingent as the backup(s). You can designate a beneficiary as 100% or in split percentages. A common example could be as follows:

• Primary Beneficiary - 100%: Spouse

• Contingent Beneficiary #1 - 50%: Adult Child # 1

• Contingent Beneficiary #2 - 50%: Adult Child # 2

In most cases, the official beneficiary designations avoid probate, so they must be up to date. Probate is the legal proceedings of settling an estate, which can be costly, time-consuming, and stressful for family members.

Where To Name Beneficiaries

It is very straightforward and is typically an easy process to name (or make updates to) your beneficiaries on retirement plan accounts (like 401(k)s, 403(b)s, IRAs, etc.) and life insurance policies. You can also "add" beneficiaries to taxable investment accounts (brokerage, individual, joint, etc.) or bank accounts via a Transfer-On-Death (TOD) or Payable-On-Death (TOD) designation. This is an excellent option for anyone who does not have a Revocable Living Trust. You may elect to put beneficiaries for other properties like your home, rental real estate, and other assets. Finally, it’s critical to seriously consider your digital assets. Preparing a plan for your digital assets could be as simple as listing someone as an interested party on certain investment accounts or as nuanced as the idea of a “legacy contact” for electronic data. For example, Apple allows listing a legacy contact on their Apple ID. Doing so would allow that person you choose to access your electronic data after passing away.

An Official Beneficiary Designation Can Be More Powerful Than Your Will

Many people think that wills are the end-all-be-all of estate planning, but your will isn’t your most powerful tool. In most cases, official beneficiary designations, like on a life insurance policy, 401(k), 403(b), IRA, or bank account (TOD/POD), supersede what’s in your will. Let’s look at an example. Say you recently went through a divorce and, a few years later, re-married. Your ex-spouse is the official primary beneficiary of your core documents. Though you forgot to update those documents, you did update your will to reflect your new spouse. If you passed away, your ex-spouse would get your assets, not your new spouse. This outcome is likely not ideal and could cause contention, court proceedings, and a lot of time/money. Beneficiary designations are critical to the wealth transfer process, so they should remain up-to-date.

When And Why To Update Your Beneficiaries

Keeping beneficiaries current brings continuity to your estate plan. When everything is updated, there shouldn't be any surprises for your loved ones. It’s best to review your beneficiary designations every few years and update them with significant life changes: marriage, divorce, children, a new job, a big move, etc. In addition to life changes, it is important to consider relevant changes to tax or estate law. This is more challenging to keep a pulse on. Still, a trusted advisor, attorney, or tax professional should keep an eye out for such legislative changes that could impact your financial picture. As your wealth grows and your financial journey progresses, ensure that your beneficiary designations, will, and trust (if applicable) are all aligned.

Keep Tax Planning In Mind

Selecting beneficiaries is essential, especially through the lens of legacy and tax planning. You want to be strategic about who you list on your official accounts (401k, IRA, investments, etc.) and in your will or trust. When there’s a mismatch, there will likely be more problems. Furthermore, you may want to consider the tax ramifications of listing certain people or institutions as primary beneficiaries of different types of assets.

• When does it make sense to name a loved one, charitable institution, or trust as the beneficiary?

• Should your sister be the beneficiary of your IRA? 

• What would the tax implications be for your niece inheriting the family house? 

• How can you leave some money to family and charity?

Your financial team (financial advisor, estate planning attorney, and tax professional) can help you create a deliberate plan that honors and upholds your legacy. We can help you review the tax consequences of these decisions to bring additional context and intention to your plan. We’d love to be a part of your journey in building your estate plan. Reach out today.