A beneficiary is a person or organization that is designated to receive assets from a will, trust, life insurance policy, retirement account, or other financial account. Choosing your beneficiaries carefully and keeping those designations up to date is one of the most important and most overlooked aspects of estate planning.
Types of beneficiaries
There are several types of beneficiaries depending on the context:
- Primary beneficiary — the first person or organization in line to receive assets. If the primary beneficiary is alive and able to receive the assets at the time of the account holder’s death they receive the full benefit.
- Contingent beneficiary — also called a secondary beneficiary, this person or organization receives assets only if the primary beneficiary is unable to — for example because they have already died or have declined the inheritance
- Revocable beneficiary — a beneficiary designation that can be changed at any time by the account holder
- Irrevocable beneficiary — a beneficiary designation that cannot be changed without the beneficiary’s consent — common in some insurance policies and divorce settlements
Where beneficiary designations are used
Beneficiary designations are used on a wide range of financial accounts and legal documents including:
- Life insurance policies
- Retirement accounts such as IRAs, 401(k)s, and 403(b)s
- Bank accounts with a payable-on-death designation
- Investment accounts with a transfer-on-death designation
- Annuities
- Wills and trusts
How beneficiary designations work
When you name a beneficiary on a financial account or insurance policy that asset passes directly to the named beneficiary when you die — without going through probate court. This means the asset is transferred quickly and privately regardless of what your will says.
This is a critical point that many people do not realize — a beneficiary designation on a financial account overrides your will. If your will says your estate should go equally to your three children but your retirement account names only one child as beneficiary that child receives the entire retirement account regardless of what the will says.
Why keeping beneficiary designations up to date is critical
Outdated beneficiary designations are one of the most common and costly estate planning mistakes. Common problems that arise from outdated designations include:
- A former spouse receiving assets after a divorce because the beneficiary designation was never updated
- A deceased person remaining as the named beneficiary causing the asset to go through probate
- Assets passing to a minor child who cannot legally manage them requiring court appointment of a guardian
- Assets passing to a person with a disability causing them to lose government benefits
- Assets not reflecting the account holder’s current wishes due to changed family circumstances
Life changes that should trigger a review of beneficiary designations include marriage, divorce, the birth of a child, the death of a named beneficiary, and significant changes in family relationships.
Naming a minor child as beneficiary
Naming a minor child directly as a beneficiary can create significant problems. Minor children cannot legally receive large sums of money directly. If a minor is named as beneficiary a court may need to appoint a guardian of the property to manage the funds until the child reaches adulthood — typically age 18 or 21 depending on the state.
Better options for leaving assets to minor children include:
- Naming a trust as beneficiary and designating the child as the trust beneficiary with a trustee to manage the funds
- Naming a custodian under the Uniform Transfers to Minors Act — UTMA — to manage the funds until the child reaches a specified age
Naming a person with a disability as beneficiary
Naming a person with a disability directly as a beneficiary can disqualify them from needs-based government benefits such as Medicaid and Supplemental Security Income. A better approach is to name a special needs trust as the beneficiary with the person with a disability as the trust beneficiary. This allows the assets to be used for the person’s benefit without affecting their government benefit eligibility.
Naming your estate as beneficiary
Naming your estate as the beneficiary of a life insurance policy or retirement account is generally not recommended. When your estate is named as beneficiary the asset must go through probate which can be time consuming and expensive. It also means the asset is subject to your estate’s creditors.
It is almost always better to name a specific person, trust, or organization as beneficiary rather than your estate.
Beneficiaries and retirement accounts
Retirement accounts such as IRAs and 401(k)s have special rules regarding beneficiaries. The SECURE Act of 2019 and subsequent legislation changed the rules for how non-spouse beneficiaries must withdraw inherited retirement account funds. Under current rules most non-spouse beneficiaries must withdraw all funds from an inherited retirement account within 10 years of the original account holder’s death.
Spouses who inherit a retirement account have more flexibility including the option to roll the account into their own IRA and defer withdrawals according to their own timeline.
How to update beneficiary designations
Updating beneficiary designations is generally a straightforward process:
- Contact the financial institution, insurance company, or employer that holds the account
- Request a beneficiary designation change form
- Complete the form with the names, dates of birth, Social Security numbers, and relationship of your chosen beneficiaries
- Submit the completed form according to the institution’s instructions
- Keep a copy of the completed form for your records
- Confirm with the institution that the change has been processed
Many financial institutions now allow beneficiary designations to be updated online through their account portals.
Reviewing beneficiary designations regularly
Financial advisors and estate planning attorneys recommend reviewing all beneficiary designations at least every three to five years and after any major life event. Creating a comprehensive list of all accounts and their current beneficiary designations can make this review process easier and help ensure nothing is overlooked.
Key terms to know
- Beneficiary — a person or organization designated to receive assets from a financial account or legal document
- Primary beneficiary — the first in line to receive assets
- Contingent beneficiary — receives assets only if the primary beneficiary cannot
- Payable-on-death designation — a beneficiary designation on a bank account that allows funds to pass directly to the named beneficiary without probate
- Transfer-on-death designation — similar to payable-on-death but used for investment accounts and in some states real estate
- Special needs trust — a trust used to hold assets for a person with a disability without affecting their government benefit eligibility
- SECURE Act — federal legislation that changed the rules for inherited retirement accounts
Sources
- Internal Revenue Service — irs.gov
- Social Security Administration — ssa.gov
- American Bar Association — Public Resources
- USA.gov — Estate Planning
This article is for general informational purposes only and does not constitute legal or financial advice. Laws vary by state and are subject to change. Consult a licensed attorney or financial advisor for guidance specific to your situation.