8 Mistakes to Avoid When Naming Beneficiaries

By Mitchell J. Smilowitz, CPA

Naming beneficiaries for your retirement account – as well as other assets you own – is a fundamental, but often over-looked, part of your financial plan. We establish a beneficiary when we first open the account and then forget about it. Like any part of your financial plan, it is useful to review your beneficiaries every few years or after a major lifecycle event such as a wedding, a divorce, the death of a loved one or birth of a child, to make sure you are not falling into one of these 8 mistakes.

This article focuses on beneficiaries chosen for your retirement accounts and life insurance. Note that these accounts will always be inherited by the designated beneficiaries on file regardless of what is written in your will or trust. Your will or trust govern the disposition of assets such as real estate, bank accounts and non-retirement investments.

We begin this discussion with a basic assumption – you want to ensure that your intended heirs receive the proceeds of your retirement funds and life insurance policies.

What are the mistakes to avoid?

#1 – Not Naming a Beneficiary

When you have not named a beneficiary for a retirement account or a life insurance policy, inheritance of those assets is determined by law in the state in which you live. Make sure all of your accounts and policies name the beneficiary you want to receive the proceeds.

#2 – Not Naming a Contingent Beneficiary

A contingent beneficiary inherits your assets if your beneficiary predeceases you. If you have not named a contingent beneficiary and your beneficiary has died, your assets will be treated as if you had not named a beneficiary at all. In other words, the distribution of your assets will be determined by state law where you live.

#3 – Naming an Estate or Trust

Assets which are passed to an estate as a beneficiary face unique challenges. For retirement plans, such as the plan offered by the JRB, this means that the assets have to be liquidated and paid to the estate within five years after death. Once the assets are liquidated, the estate will need to pay income taxes on the proceeds. When individuals are named the beneficiary of a retirement account, they can have the assets of the account paid out over their lifetimes.  This allows them to stretch the tax liability over many years. Because an estate must withdraw the money from the account faster, it may also pay taxes at a higher rate than individuals.

Naming a Trust can also have unintended consequences. If there is a non-person beneficiary, such as a charity, listed in the Trust, the Trust will need to be liquidated within five years. However, a Trust may make sense if your beneficiary is a person with special needs or someone you do not believe will handle the money prudently.

#4 – Having Outdated Beneficiaries

Outdated beneficiaries are a disturbingly frequent occurrence. Many people set a beneficiary and never review it. Many years later, their heirs find that the named beneficiary has already died. Or, the named beneficiary is a former spouse. Or, that one or more children are not named as beneficiaries.

Make sure that the beneficiaries you’ve named for your JRB account, other retirement accounts and life insurance policies reflect your current desires.

#5 – Naming Minors as Direct Beneficiaries

If you name a minor as your beneficiary, it is important that you also name a guardian. Many institutions will not award benefits directly to a minor. If one is not named in your will, a probate court will assign a guardian to manage the funds. Some states allow the minor to receive the assets at age 18 or 21. Speak with an attorney on how best to balance the needs of your heirs with the desire to maintain control of the assets through someone you trust.

#6 – Naming Special Needs Individuals as Direct Beneficiaries

Naming special needs individuals as direct beneficiaries raises an additional issue. Many government benefits available to special needs individuals are income based. Naming a special needs individual as a direct beneficiary may disqualify that person from receiving government benefits. While there are many reasons to avoid naming a Trust as beneficiary, it may make sense to do so for the benefit of a special needs individual.

#7 – Naming Different Children as Beneficiaries for Separate Accounts

If you have more than one retirement account or life insurance policy, assigning separate accounts to each child looks like a simple solution. But consider this. While the amounts may have looked equal when you set up the beneficiaries, over time the balances may grow disproportionately. Naming all of your children as joint beneficiaries of each account assures each beneficiary will receive the amount you intend.

#8 – Naming One Child as the Sole Beneficiary

A parent with several children may designate one of them as the sole beneficiary of an account with the thought that this child will use the proceeds to pay for the funeral and distribute the rest to their siblings. However, your child is under no legal obligation to use this money as you intend. Designating the proceeds from your account to a single child also increases the tax liability for that child. This can make it more difficult and costly for the child to carry out your wishes. 

Don’t make these 8 mistakes! If needed, contact your attorney to review your estate plan and contact the JRB via email or call 888-JRB-FREE (572-3733) to review the beneficiary designations for your JRB retirement account and our complimentary term life insurance policy and update them if needed.