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Updating your Beneficiary Designations
James P. Terwilliger, PhD, CFP® is Senior Vice President - Financial Planning Officer and can be reached at JTerwilliger@CNBank.com
or (585) 419-0670 x50630.
We constantly remind clients to review their estate plans, making sure that wills and other estate planning documents (powers of attorney, living wills, and health care proxies) are up to date.
Doing so is necessary but not nearly sufficient.
What is equally important is to review and update beneficiary designations.
First, beneficiary designations trump the will. That is, assets such as IRAs, Roth IRAs, qualified employer retirement plans, life insurance death benefits, and deferred annuities all pass to heirs via beneficiary designations provided to plan administrators by the owner. Generally, the will only becomes involved when no beneficiaries are named. In this case, the estate is the default beneficiary.
Second, it is far better to name individuals and/or charities as beneficiaries of IRAs and qualified employer retirement plans rather than the estate.
The ability to roll over or inherit, then ultimately “stretch” pre-tax accounts over the individual beneficiaries’ lifetimes, is worth its weight in gold. If a beneficiary is not named and the estate becomes the default beneficiary, the estate is generally required to liquidate the entire account and pay the resulting income tax on such at highly-aggressive ordinary income tax rates.
Naming a charity as full or partial beneficiary of IRA, qualified employer plan, and deferred annuity accounts containing pre-tax dollars is a very smart option to consider. By doing so, not a penny of income tax will ever be paid on these assets.
Rather than leave after-tax dollars to the charity and pre-tax dollars to family members who will then have to pay income tax when distributions are ultimately taken, consider doing just the opposite. Fund charitable bequests from pre-tax accounts via beneficiary designation and fund bequests to family members from after-tax accounts via the will.
The beauty of the latter is that after-tax assets get a step up in tax cost basis on death, resulting in no income tax consequence to the heirs.
The above guidance does not hold for Roth IRAs. They should always be passed along to individuals either directly or through a trust.
Life insurance death benefits are directed by beneficiary designation. Generally, it is best to direct such proceeds to individuals or trusts. This ensures that the money flows immediately and is not delayed awaiting probate. In some instances, directing these proceeds or a portion to the estate is advised to ensure that the estate has adequate liquidity.
Some additional planning issues follow below.
Name contingent beneficiaries – In most cases, contingent (and sometimes third-level beneficiaries) should be named. This takes care of situations in which the primary and/or contingent beneficiaries pass first. It also allows for a hierarchy of pathways in case primary and/or contingent beneficiaries wish to disclaim part or all of the bequest. This is a flexible and smart estate planning tactic.
Be specific – When naming individuals, it is best to list specific names and associated information (date of birth, Social Security number, relationship, address, and % of total allocation) rather than just referring to a class of beneficiaries (children, for example).
Keep designations up to date – Typically, beneficiary designations are made over a period of years, oftentimes over decades. Over such a span of time, family members die and/or are born, marriages dissolve, and other circumstances change. It is no wonder that designations can end up to be highly inconsistent across one’s IRAs, employer retirement plans, and life insurance policies.
Don’t guess on this one. Make a list of all accounts/policies that have beneficiary designations, contact the associated administrators, and confirm. Correct any inconsistencies by filing new forms.
Be sure to keep updated copies of all beneficiary designation forms in your personal files.
Consider the financial and emotional readiness of your beneficiaries – Pre-tax accounts and life insurance proceeds left directly to beneficiaries generally can be fully accessed by such beneficiaries. In other words, they can be emptied and spent. If your heirs are not prepared to handle such an inheritance, consider appropriately-designed trusts as beneficiaries. With trusts created during your lifetime or at death through your will, you can specify the ground rules and timeframe for your beneficiaries’ access to the assets.
Seek professional guidance - As with other important financial matters, be sure to partner with a trusted financial planner and an attorney to ensure that the design of your beneficiary designation array represents your interests and is consistent with your overall estate plan. This exercise is much too important to try on your own.
This material is provided for general information purposes only and is not a recommendation or solicitation to buy or sell any particular security, product or service. Past performance is not indicative of future investment results. Any investment involves potential risk, including potential loss of capital. Before making any investment decision, please consult your legal, tax and financial advisors. Non-deposit investment products are not bank deposits and are not insured or guaranteed by Canandaigua National Bank & Trust, or any federal or state government or agency and are subject to investment risks, including possible loss of principal amount invested.