Beneficiary designations are an important part of estate planning that are sometimes overlooked. They allow you to specify who will receive certain assets like retirement accounts, life insurance policies, and bank accounts after you pass away. Unlike a will, these designations typically override any other estate planning documents. 

It's crucial to periodically review your beneficiary designations and update them as needed, especially after major life events. Outdated or incorrect designations can lead to your assets being distributed in unintended ways. Here's what you need to know about beneficiary designations and best practices to manage them properly.

Understanding Beneficiary Designations

A beneficiary designation names the person(s) or entity who will receive that specific asset upon your death. You can designate one or more primary beneficiaries as well as contingent beneficiaries. If the primary beneficiary predeceases you, the asset passes to the contingent beneficiary.

Common types of assets that use beneficiary designations include:

• Employer-sponsored retirement plans like 401(k)s and pensions
• Individual Retirement Accounts (IRAs) 
• Life insurance policies
• Annuities
• Transfer-on-Death (TOD) investment accounts 
• Payable-on-Death (POD) bank accounts

Beneficiary designations are considered "will substitutes" because they override what is specified in your will. For example, if your will states your daughter will inherit everything, but your 401(k) lists your ex-spouse as the beneficiary, your ex-spouse will receive the 401(k) funds.

Why Updating Designations is So Important

Keeping your beneficiary designations up-to-date is critical for several reasons:

1. Changing life circumstances- Marriages, divorces, births, deaths, and other life events may change who you want to inherit certain assets. Updating designations ensures your assets pass according to your current wishes.

2. Unintended consequences - Outdated designations can result in assets passing to unintended heirs like an ex-spouse or a predeceased relative's estate. This can cause financial and emotional stress for your loved ones.

3. Newly acquired assets - As you accumulate new accounts and policies over time, you need to specify beneficiaries for each one. Failure to do so could mean the asset will pass through probate, a lengthy and public court process.

4. Beneficiary's changed circumstances - A beneficiary may develop special needs, financial irresponsibility, or substance abuse issues. Updating designations can better protect their inheritance.

5. Tax implications - The SECURE Act changed rules around inherited retirement accounts. In most cases, non-spouse beneficiaries must now withdraw all funds within 10 years, potentially causing unfavorable tax consequences. Reviewing your designations with a financial advisor or CPA can help optimize tax outcomes.

Best Practices for Beneficiary Designations

Here are some tips to help ensure your beneficiary designations are properly managed:

Name primary and contingent beneficiaries 

Naming both primary and contingent beneficiaries helps ensure your assets will pass as intended even if a primary beneficiary predeceases you. Without a contingent, the asset may pass to your estate and go through probate.

Update for life events

Review your designations after any major life changes like marriage, divorce, birth of a child or grandchild, or death of a beneficiary. Make updates as needed to align with your current situation and wishes.

Coordinate with your will and trust

While beneficiary designations override these estate planning documents, it's still wise to coordinate them. This helps avoid confusion and makes your final wishes clear. Consult an estate attorney for guidance.

Consider the impact on government benefits

Naming a beneficiary who relies on needs-based government benefits can jeopardize their eligibility. Consider establishing a special needs trust and naming it as the beneficiary instead to protect their benefits.

Avoid naming minors directly

If a minor child is named as a beneficiary, a court will appoint a guardian to manage the funds until they reach 18 or 21. Naming a trust for their benefit or a trusted adult as a custodian can prevent this.

Use caution with trusts

Consult an estate attorney before naming a trust as a beneficiary. Certain trusts are not eligible to be designated beneficiaries of retirement plans. An attorney can help structure it properly for your situation.

‍Keep your own copy of designations

Don't rely on your employer or financial institution to maintain your beneficiary designation forms indefinitely. Keep a copy with your important documents and provide copies to your executor and trusted family members.

Obtain spousal consent if needed

If you're married and want to name someone other than your spouse as beneficiary of an employer retirement plan, you may need spousal consent. Some plans have additional restrictions as well.

How to Update Beneficiary Designations

The process to update beneficiaries is fairly simple but varies by the type of asset:

Employer retirement plans - Request a new beneficiary designation form from your human resources department or plan administrator. Fill it out, sign it, and return it. Keep a copy for your records.

IRAs, life insurance, and annuities - Contact the financial institution or insurance company and request a new beneficiary designation form. Follow their instructions to complete it and keep a copy.

Transfer-on-Death accounts - Request a TOD beneficiary form from the financial institution where you hold the account. Once you've completed it, the assets will pass directly to your named beneficiaries.

Payable-on-Death accounts - Ask your bank or credit union for a POD designation form. After completing it, the account's balance will be paid directly to beneficiaries upon your death.

The Importance of Communicating Your Wishes

In addition to keeping your beneficiary designations updated, it's wise to communicate your wishes to your beneficiaries and trusted family members. This can help prevent confusion, hard feelings, and even legal challenges after you're gone. 

While you don't necessarily need to share copies of your designations, consider putting together a list of your accounts and policies, including where they're held and who the beneficiaries are. Keep this with your other estate planning documents and make sure your executor knows where to find it.

It's also a good idea to discuss your overall estate plan with your loved ones. This allows you to explain your choices and share your rationale. While these conversations can feel awkward, they often bring greater peace of mind in the long run.

When to Seek Professional Guidance

Beneficiary designations can seem straightforward, but there are situations where professional advice is warranted. Consider consulting an estate planning attorney, financial advisor, or CPA if:

• You have a large or complex estate
• You want to name a trust as beneficiary 
• You're trying to minimize taxes
• You have beneficiaries with special needs
• You're remarrying and have children from a prior marriage
• You want to donate some assets to charity
• You own a business or real estate in multiple states

These professionals can help ensure your beneficiary designations are properly structured and coordinated with your overall estate plan. They can also help you navigate complex situations and optimize your plan for tax purposes.

Conclusion

Beneficiary designations are a crucial part of estate planning that require careful consideration and ongoing maintenance. Keeping them up-to-date ensures your assets will pass to your intended heirs and can prevent a host of problems down the road. 

By following best practices, communicating your wishes, and seeking professional guidance when needed, you can feel confident your loved ones will be taken care of according to your desires. Consider reviewing your designations once a year and after any major life changes. A little proactive planning now can make a world of difference for your beneficiaries later.

Material prepared herein has been created for informational purposes only and should not be considered investment advice or a recommendation.  Information was obtained from sources believed to be reliable but was not verified for accuracy.  It is important to note that federal tax laws under the Internal Revenue Code (IRC) of the United States are subject to change, therefore it is the responsibility of taxpayers to verify their taxation obligations. 

Savvy Wealth Inc. is a technology company.  Savvy Advisors, Inc. is an SEC registered investment advisor. For purposes of this article, Savvy Wealth and Savvy Advisors together are referred to as “Savvy”.  All advisory services are offered through Savvy Advisors, while technology is offered through Savvy Wealth.  The views and opinions expressed herein are those of the speakers and authors and do not necessarily reflect the views or positions of Savvy Advisors.