No matter the state of your finances, it’s important to think about what will happen to your accounts if you pass away unexpectedly. After all, this could have a major impact on the well-being of your family. One of the things you can do to help secure their future is to set up beneficiaries.
What is a beneficiary?
Put simply, a beneficiary is somebody who receives your assets at your death. Generally, these are only available for certain types of accounts, such as individual retirement accounts and life insurance policies. According to certified financial planner Justin Pritchard, there are two different types of beneficiaries: primary and contingent. The primary beneficiary is your first choice, while the contingent beneficiary is a backup in case the primary beneficiary is no longer living.
However, you’re not limited to just one of each. “You can have multiple primary beneficiaries in some cases,” Pritchard says. “You could have three primary beneficiaries, all of which receive 33.3 percent of assets.” You can even name a trust or your estate as a beneficiary, though if you want to leave money to a minor, you should consult an estate planning attorney as that’s a more complicated matter.
Why is a beneficiary important?
Naming a beneficiary helps eliminate confusion after your death. By setting up a beneficiary for all of your accounts, you leave no doubt as to what should be done with your insurance proceeds and hard-earned money. This can save time and headaches over paperwork, as well as ensure the financial well-being of your loved ones in a timely manner — which is particularly important if the money in one of your accounts was meant to cover funeral expenses.
“If you pass away without naming beneficiaries…it can create legal entanglements for your heirs,” writes financial expert George D. Lambert. He explains that even if you have a will, your loved ones must still go through the probate process to get what you left them. This can be expensive and take a long time if they fight over your assets. Designating beneficiaries simplifies the whole process and leaves no room for argument. “You list who will get the money and what percentage each will receive,” Lambert says. “Then, after you die, your beneficiaries present a death certificate to the financial institution and fill out a form. The check arrives in a few weeks. There's no probate, no court involvement, no expense.”
Life insurance and annuities
According to Julia Kagan, personal finance editor for Investopedia, life insurance proceeds are tax-free to the beneficiary. They are also not reported as gross income. Nonetheless, she adds that “any interest received or accrued is considered taxable and is reported as any other interest received.” Most life insurance and annuity companies have forms that allow you to decide how beneficiaries receive the death benefit. Typically, you would choose between three payment options: lump-sum, period certain and amortization over the beneficiary’s life expectancy. You may even combine payment methods; for example, you could have your beneficiary receive a portion of the death benefit as a lump sum, with the rest paid over time. Just remember that the standard form used by the financial institution might not be good enough for you, so it’s advisable to work with an expert to ensure everything is the way you want it.
Individual retirement accounts
Unlike life insurance and annuities, individual retirement accounts normally pay out based on the institution’s own policy, not what you dictate. Furthermore, only your spouse, if named as the primary beneficiary, can inherit your IRA and treat it like their own retirement account. They may be able to roll it into their existing IRA or leave it as an inherited IRA; and once they have inherited your IRA, they can also name their own beneficiaries for it. This can be a downside if, for example, your spouse remarries and passes along your IRA assets to someone else while leaving out your children. One of the ways to get around this is to name a trust as the beneficiary of your IRA, which can help protect your assets. However, this can also be costly and must be precisely drafted to accomplish what you want. As a result, it’s best to first explore your options and, if you are set on designating a fund as your IRA beneficiary, to do so with a financial attorney.
Setting up beneficiaries for your accounts is one of the most important parts of estate planning. And because there’s no way to know for certain when you will pass away, it’s also important to get it done right the first time, as well as every subsequent time you review your plans. Because of this, it can truly pay off — for your loved ones — to hire expert financial help.