Personal Finance Essentials
Beneficiary Designations – One of Your Most Important Decisions
Your Will Is Irrelevant If You
Never Updated This Form
Each time you open a retirement account or IRA, you are asked who gets the money when you die. The person you name is your beneficiary. You are also asked to name a secondary beneficiary (also called a contingent beneficiary), who receives the money if the primary beneficiary predeceases you.
Beneficiary designations are powerful because they override your will. Whatever name appears on the form controls – not the instructions in your will or trust. That makes it essential to keep your designations current.
Here is what can happen when a beneficiary designation is never updated. A man participates in his retirement plan at work and names his wife as his primary beneficiary. They divorce. Years later, he remarries. They have a child. He never updates his beneficiary form. When he dies, his widow contacts his employer and discovers that his first wife – whom he hadn’t seen in more than 30 years – is still listed as the beneficiary. The first wife gets the money. His widow and their child receive nothing.
In another case, a court distributed more than $300,000 from an employee’s retirement account to his six siblings rather than to the two stepsons he had called his “beloved sons” in his will. He had never updated his beneficiary designation after his wife died, and the boys had never been legally adopted. The court upheld the distribution to the siblings. It took six years and tens of thousands of dollars in legal fees for the outcome to be final.
Review your beneficiary designations whenever your marital status changes, when family members are born or die or when your feelings about any family member change. Do not assume that your will takes care of these accounts. It does not.
When You Inherit a Retirement Account
If you are the surviving spouse of an IRA owner, you generally have the most flexibility. You can transfer the inherited funds into an IRA in your own name, which allows you to delay required minimum distributions until you reach the applicable age and to name your own beneficiaries. This is typically the best choice for spouses who do not need immediate access to the funds.
If you are a non-spouse beneficiary, you should create a Beneficiary IRA (also called an Inherited IRA). If two or more people are beneficiaries, each should establish a separate Inherited IRA. You will generally be required to begin taking distributions based on your life expectancy, following IRS actuarial tables. These rules allow you to extend the tax-deferred growth over many years, which can be a significant financial benefit.
In either situation, consult a financial planner or tax advisor before making decisions. The rules are complex, the stakes are high and mistakes can be costly.