Do you know who's listed as a beneficiary on your retirement accounts or life insurance policies? If you haven't looked at these files for a bit, now is a good time to check.
Many people have prior spouses or deceased relatives who are named as beneficiaries of these accounts. The problem is that these beneficiary designations are legally binding, and they supersede your will. The asset will go to the person you name on the form regardless of what your will says.
These beneficiaries might have no idea that they'll receive these accounts when the policyholder passes on. They—and the loved ones you intended to receive them—could be in for a surprise.
Beneficiary Designations Trump the Will
Many people neglect to update their beneficiary designations after marriage, divorce, or other life changes. It's easy to forget, and some people think an updated will is all they need.
But your will or your living trust won't override the beneficiary designation on a life insurance policy, an annuity, or a retirement account, such as an IRA or 401(k) plan.
What if you don't name anyone at all as beneficiary on an IRA account? Then it will revert to your estate. In that case, your will would take precedence (if you left a will). Otherwise, your state's inheritance laws would get involved.
Update your beneficiaries to reflect your current wishes so that state laws won't determine who will receive the money.
An Example of Planning Gone Bad
Take the example of an individual who worked for a large national defense company. This person was married and had children from a previous relationship. Shortly after learning that they were ill with cancer, they had a trust drawn up. The goal of the trust: to ensure that their two children and their spouse each got one-third of their assets.
Unfortunately, this person didn't update their beneficiary designation with their 401(k) plan, so the entire account went to the spouse. The spouse wanted to honor the deceased's wishes. However, they would have had to report all of the income on their tax return. They also would owe taxes on all amounts withdrawn at their tax rate, if they were to cash in the 401(k) and give shares to the deceased's children.
The surviving spouse and children decided to set up an IRA in the spouse's name instead, and roll the funds over into it to avoid a big tax hit. The children would be named as the beneficiaries of the new account and would receive distributions from it. They agreed that the spouse would withhold enough to cover the taxes. This is legally allowed.
But it would be an ongoing administrative hassle for years. All of this could have been avoided if the deceased had updated their retirement plan documents.
The employer had no choice but to follow the beneficiary designation form on file. Employers can't change the distribution after death, even if all parties agree to the change.
How to Review Beneficiary Designations
Make a list of each account, policy, and annuity that you have. Add two columns to your list: one for the beneficiary, and one for a date. Write down the beneficiary and the date when it was last updated for each account or policy.
You should also name a contingent beneficiary in addition to a primary beneficiary. This lets you specify whom the account should go to if the primary beneficiary predeceases you.
Keep this list in a binder or file folder along with your other important documents. Make a habit of pulling out this binder once a year and checking it.
Contact the company if you need to update a beneficiary. They'll send you a form that you can fill out, sign, and return.
What About a Living Trust?
Many people establish revocable living trusts to govern disposition of their assets, which are titled into the name of the trust after it's formed. You could title bank accounts, investment accounts, and real estate in the name of the trust. You would be the trustee, and you would have complete control over the assets during your lifetime.
The trust document would name a successor trustee to take over management of the trust if needed.
A "real person" must be the account owner with an IRA or 401(k), however. You can't re-title an IRA or 401(k) into the name of a trust. You can name the trust as the beneficiary of your IRA, but there can be drawbacks to this approach.
It's best to work with an estate planning attorney to help you figure out the best way to name beneficiaries if you have assets in IRAs and other plans or policies.