When you think about your estate planning documents, you also need to spend some time on assets that will not be covered by your will or trust. Beyond those core documents, you can use "designated beneficiaries" to add a layer of efficiency, clarity, and protection for your loved ones. Designated beneficiaries—individuals named to directly receive assets such as life insurance proceeds, retirement accounts, or bank accounts—simplify the transfer process and often bypass probate, ensuring faster and more secure distribution of your estate.
Using designated beneficiaries is essential for a well-crafted estate plan and it's important to consider their role and how it will impact your legacy for your family after you've passed away.
What Are Designated Beneficiaries?
"Designated beneficiaries" are individuals or entities named on specific financial accounts or policies to receive funds or assets upon your death. These designations are typically made on forms provided by financial institutions, retirement plans, or insurance companies. Some common account types where you will find them:
- Life insurance policies: Beneficiaries are named to receive the death benefit directly.
- Retirement accounts (e.g., 401(k), IRA): Designations determine who inherits the funds in the account.
- Payable-on-death (POD) and transfer-on-death (TOD) accounts: These accounts allow you to name a beneficiary for your bank or brokerage accounts.
Designating beneficiaries ensures that these assets transfer outside of the probate process, which can be lengthy and costly.
Why Should You Use Them in Your Estate Plan?
While it seems pretty clear that these are a good strategy for your estate plan, there are three common reasons that my clients primarily cite for using them:
Avoiding Probate
Probate can be time-consuming and expensive, often delaying access to funds for loved ones. Assets with designated beneficiaries pass directly to the named individual, sidestepping probate entirely. This is particularly crucial for assets like life insurance, where beneficiaries may need funds to cover immediate expenses.
Ensuring Specific Wishes Are Honored
Designated beneficiaries take precedence over instructions in a will. For example, if you name a beneficiary for your retirement account, the funds will go directly to that person regardless of what your will states. This specificity ensures clarity and reduces disputes among heirs.
Providing Tax Benefits
In some cases, naming beneficiaries can offer tax advantages. For instance, designating a spouse as the beneficiary of a retirement account allows for spousal rollovers, which can defer taxes and provide greater financial flexibility. Before you go too far down this path, make sure you speak to your financial advisor on the most appropriate tax benefits for your particular situation.
What to Look Out For
Designated beneficiaries are not like a slow cooker - you can't just set it and forget it. It's important that you stay up to date and actively review your designated beneficiaries. Three steps you should be taking:
- Regular Updates ~ Life events such as marriage, divorce, births, or deaths may necessitate changes to your beneficiary designations. Failing to update beneficiaries can lead to unintended outcomes, such as an ex-spouse receiving funds.
- Contingent Beneficiaries ~ Always name a contingent beneficiary who will inherit the asset if your primary beneficiary cannot. This ensures your asset doesn’t revert to your estate and go through probate.
- Coordination with Your Will ~ Ensure your beneficiary designations align with your will and overall estate plan. Inconsistencies can lead to confusion or legal disputes, undermining your intentions.
Common Designated Beneficiary Mistakes
When it comes to estate planning, there can be a variety of small mistakes that can undo the legacy you've created. For example, watch out for:
- Overlooking Non-Financial Accounts: Beneficiary designations aren’t limited to financial accounts. You can name beneficiaries for assets like annuities or even digital accounts with value, such as cryptocurrency wallets.
- Failing to Name Minors Responsibly: Minors cannot directly receive assets. If a minor is a designated beneficiary, you’ll need to establish a trust or appoint a legal guardian to manage the funds until they reach legal age.
- Assuming Default Rules Are Sufficient: Default beneficiary rules, such as “per stirpes” (by branch of the family) or “per capita” (by individual), may not reflect your wishes. Clearly specifying your designations avoids unintended consequences.
Optimizing Beneficiary Designations
Looking to optimize this process? There are four specific strategies that you should consider:
- Review and Update Regularly - Set reminders to review your beneficiary designations annually or after major life events. This ensures they remain current and reflective of your wishes.
- Name Specific Individuals - Instead of vague terms like “my children,” list beneficiaries by name to avoid ambiguity. Similarly, if you wish to exclude someone, clearly state this in your estate documents.
- Consult Professionals - Work with estate planning attorneys and financial advisors to ensure your designations align with your overall plan and comply with applicable laws.
- Leverage Trusts - For complex situations, such as caring for dependents with special needs or protecting assets from creditors, consider naming a trust as a beneficiary. This provides greater control over how and when assets are distributed.
Incorporating designated beneficiaries into your estate plan is a powerful way to ensure your assets are distributed quickly, efficiently, and according to your wishes. By bypassing probate, offering tax advantages, and providing clarity to your heirs, beneficiary designations streamline the estate planning process. Regular reviews, careful selection, and professional guidance can help you avoid pitfalls and maximize the benefits of this essential tool.
Whether you’re starting your estate plan or refining it, don’t overlook the importance of designated beneficiaries. Taking the time to set them up properly today can save your loved ones time, money, and stress in the future.
Do You Need an Estate Planning Attorney?
If you need a full estate plan, let's schedule a Legal Strategy Session online or by calling my Edina, Minnesota office at (612) 294-6982 or my New York City office at (646) 847-3560. My office will be happy to find a convenient time for us to have a phone call to review the best options and next steps for you to work with an estate planning attorney to get your plan prepared and implemented.
