You can’t take your money with you, but you sure can determine who will get it and, in some cases, how they will receive it.

One item you may not have considered in quite a while is: who have you named as the beneficiary of your retirement account and/or life insurance policy? You may be surprised to find out that the beneficiary designation most often takes legal priority over such documents as a will or trust despite the fact that you most likely spent far more time and money constructing them. 

What if you forget to update the beneficiary?

Investment custodians and insurance companies are full of legendary tales of former spouses, estranged family members and even family friends who were designated to be the legal guardians of minor children who are now adult children. The individual you list as your beneficiary is the beneficiary regardless of any changed life circumstances, and the courts have confirmed this fact countless times.    

To avoid turning over in your grave one day, you should contact your retirement plan custodian [Individual Retirement Account (IRA), 403(b), 401(k)] and reaffirm that the person you named last year, five years ago, or even twenty years ago is indeed still the person you would prefer to be your beneficiary. Further, be sure to inquire about contingent beneficiaries, also known as successor beneficiaries, in case the person you named as your primary beneficiary passes before you do.  

If you have a trust you should consult with your estate planning attorney to learn how to name your beneficiaries in coordination with the terms of your trust.

The long reach of your IRA beneficiary choices

So what happens at the time of your death if one of your beneficiaries has predeceased you, but the remaining beneficiaries are still alive? For example, your three children have been named as your primary beneficiaries. Your oldest child predeceases you, but you never updated your beneficiary designation form to reflect this. Is the deceased child’s share split equally amongst the surviving two beneficiaries? Or does that share pass along to the predeceased beneficiaries’ heirs?

Well, it depends on your custodian and what you opted for when you completed the beneficiary form. There are a few technical but meaningful elections that can result in differing outcomes and economic results. Typically, most custodians will have the IRA proceeds go to your surviving beneficiaries with no consideration of the heirs of your deceased beneficiary unless this has otherwise been provided for.

If you would prefer to have the deceased beneficiaries’ share passed along to his or her heirs, see if your custodian allows for a Per Stirpes Election. This funny-sounding election allows for your beneficiaries’ heirs to receive that portion of your retirement savings thereby keeping their portion intact. Many employer plans, such as a 401(k), do not provide for this.

Leave a powerful stream of income to your beneficiaries

It is important to understand what requirements your beneficiaries will have to adhere to once the time for them to receive the funds becomes a reality…let’s hope we have some time here. Still, it is better to be prepared.

Spousal beneficiaries have the most discretion and essentially will legally take over the account(s) as if it was their own. In most cases, non-spousal beneficiaries will have the choice to:

  • deplete the account right away; 
  • deplete it in its entirety within five years; or
  • make an annual distribution small enough to make it last a lifetime as dictated by Internal Revenue Service (IRS) guidelines.

Can you guess which beneficiary option is most often taken? For some, knowing that their lifetime of savings could be cashed out and spent so quickly can be unnerving — and for good reason. This can potentially be a blown economic opportunity for your beneficiaries to create a source of income that isn’t dependent on their salaries. Fortunately, you can have input on that alternative now. 
Consider the size of your retirement savings and imagine how your beneficiaries will handle the important implications of inheriting this money. Taxes will be due on distributions the year that they are withdrawn. Also, keep in mind those investment dollars left invested will continue to be at work even after you are not.

The third alternative, dubbed a Stretch IRA, can be a powerful wealth generator. And, assuming the portfolio continues to be invested soundly, it can act like a pension for your loved ones. If this is intriguing, investigate it further and by all means communicate with your beneficiaries your desire to see them utilize that inherited account over their lifetimes or to use the proceeds in some other fashion. After all, it will be their choice, but a little coaching from you can go a long way.

Consider a trust that works specifically with your retirement savings

If your wishes cannot be solely met with a simple beneficiary election, it is time for you to see an estate planning attorney. A properly drafted trust and an equally properly stated beneficiary election can take into account far more scenarios and provide far more control of the dispersal of your life savings.

Scenarios where a trust could be helpful:

  • You have concerns that an unsuitable family member or in-law could be a benefactor or somehow receive control of the proceeds.
  • A child — minor or adult — who you fear would not be able to handle the complexity of the inherited finances.
  • A beneficiary that might be considered a spendthrift and ‘blow away the money.’
  • When you have a specific wish on how the money is to be utilized such as restricting their access or providing a structure such as the Stretch IRA mentioned above.  

In conclusion, what seems to be of minor concern now can later amount to a small mistake on a large amount of money — making that a big mistake! Treat your beneficiary elections as seriously as you do your will and other estate planning documents and hope for a long, happy life.

FPA member Scott Hughes, CFP®, MBA, is a Financial Planning Advisor and President of Hughes Financial Services, LLC, in Herndon, VA.  Hughes Financial Services, LLC, is a branch office of and Securities offered through WFG Investments, Inc. (WFG).  Member FINRA/SIPC.  Scott Hughes is a Registered Representative of WFG.


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