Beneficiary Designations: Know When (and How) to Use Them

Beneficiary designations are an important part of the estate planning process, even though they are actually dealt with outside of the estate plan itself. A designated beneficiary is a person who inherits an asset–such as the balance of an individual retirement account (IRA) or life insurance policy–after the death of the asset’s owner. There are several advantages to using beneficiary designations where possible…as well as some risks involved when relying on them wholly.

The SECURE Act, which was passed in 2019, defined what a designated beneficiary is, and outlined new rules regarding required withdrawal amounts from inherited retirement accounts. Under this act, a designated beneficiary must be a living person, and must not fall into one of the five categories below:

  • Surviving spouse
  • Child under the age of 18
  • Individual with a disability
  • Individual who is chronically ill
  • Individual within 10 years of age of the deceased

Designated beneficiaries may be revocable or irrevocable. If revocable, the owner of the asset can make changes while they are still alive. An irrevocable beneficiary has certain guaranteed rights that cannot be denied or amended.

Prior to the SECURE Act, retirement account holders were able to utilize an estate planning strategy referred to as a stretch IRA. The stretch IRA allowed the account to be withdrawn over a long period of time, as distributions were based on the life expectancy of the person taking withdrawals.

Now, designated beneficiaries of inherited retirement accounts are subject to the 10-year rule. This means the remaining balance held by the inherited account must be withdrawn within 10 years following the account holder’s death. While seemingly stringent, this rule does allow flexibility in regard to when the distributions are taken. Since there is no required minimum distribution for any one year, a designated beneficiary can take withdrawals when it best suits their tax planning needs.

There are several benefits to using beneficiary designations as part of your estate planning strategy. The first is that they allow assets to be transferred quickly to your heirs. Upon presenting the financial institution with proof of death, the asset is subject to immediate transfer to the designated beneficiary–no probate court required! Another benefit is related to tax-deferred retirement accounts. You can often minimize the immediate income tax liability for those inheriting a share in the IRA by properly naming eligible designated beneficiaries.

These benefits set aside, it’s important for you to avoid these three mistakes when naming your designated beneficiaries:

  • Not naming a beneficiary at all. If you do not name a beneficiary for life insurance or retirement accounts, then the financial organization may have its own rules about where the assets go after you die, or your estate may be subject to probate.
  • Not using the correct name. Any discrepancy between the name listed as your designated beneficiary and your beneficiary’s actual legal name can cause delays in payouts, and–worst case–if there is another person (or people) with similar names, it can result in litigation.
  • Not updating beneficiaries over time. Circumstances change throughout your life, and you may want to name different beneficiaries during different phases of your life. It is important to make sure these designations are updated regularly.

Relying solely on beneficiary designations to avoid probate is not recommended. Working with a qualified estate planning attorney to structure a foolproof plan that meets all of your wants and needs is the best way to ensure your legacy unfolds exactly as you want it to. Contact us today to discuss your estate planning goals, or to review your current estate plan to ensure it still meets your needs.

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