The Planner's Perspective: Top 5 Beneficiary Designation Mistakes

By Paul Morrone CFP®, CPA/PFS, MSA

Part of any sound financial plan is having a complete plan designed to manage your legacy if you don’t wake up for breakfast in the morning. This often involves establishing a process to simplify estate administration, mitigate taxes, and efficiently distribute assets to or for the benefit of your loved ones and heirs. Well thought out estate plans do not have to be overly complex, but often involve the coordination of your estate planning documents (wills, trusts, POAs, etc.) along with beneficiary designations to work effectively. One incorrect beneficiary designation can corrupt an entire estate plan, which can cause unnecessary stress, costs and taxes if not proactively addressed. Below are 5 of the most common mistakes we see regarding beneficiary designations:

• Not naming a beneficiary – As obvious as this sounds, it is very common for 401(k) participants who are auto-enrolled in their company’s plan to have not designated a beneficiary because they are not forced to make an election at the time of enrollment. If a beneficiary is not designated, the funds in the retirement account will pass through the decedent’s estate, effectively eliminating some of the favorable spousal rollover/inherited IRA provisions which can cause confusion and unfavorable tax treatment for the surviving spouse or other beneficiaries.
• Outdated/Inaccurate beneficiary designations – Ex spouses, estranged children, deceased relatives and children with mental health or addiction issues are not ideal candidates to be named beneficiaries. Often, dealing with issues that arise from any of the above circumstances is emotional, and updating beneficiaries to account for changes in your personal life are commonly forgotten. The scary part is that if you do pass away and your listed beneficiary is someone that you no longer want to inherit your money, too bad!
• A will is NOT a beneficiary – There is a lot of confusion regarding wills and their role in the estate plan. While they do have a critical purpose that is beyond the scope of this article, having a will is not a substitute for naming a beneficiary. In fact, your beneficiary designation will override what you have written in your will, further emphasizing how important it is to keep beneficiary designations up-to-date.
• Funds to minors - Leaving any assets to a minor individual has its own set of challenges, and if funds are going to be left to a minor you will need to designate a custodian to hold the assets for the minor until they reach the age of majority. This can be done through the will or directly in the beneficiary designation, however, it may be wise to consider a trust if you have a substantial amount of money that could pass to your minor children.
• Trust as beneficiary – This is inherently a complex topic, but one main point to consider is that not all trusts can accommodate owning qualified (IRA, 401(k), etc.) funds. To do so, they must be drafted appropriately as a “see-through” trust and meet very specific requirements to comply with IRS rules. Additionally, if there is more than one income beneficiary in the trust document (who will ultimately benefit from the IRA funds), the beneficiary designation should be specific to the sub-trust to be established for each named trust beneficiary to qualify for stretch IRA treatment.