Why Beneficiary Designations Override Your Will

It's critical to review beneficiary designations.

Signing will
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When was the last time you checked to see who you named as the beneficiary on your retirement accounts, life insurance policies, and annuities? It is amazing the number of people who have prior spouses or deceased relatives still named as a beneficiary on a retirement account at a former employer, or on a life insurance policy purchased long ago. These people may have no idea that they would receive insurance benefits when the policyholders pass on, but they may end up getting a "pleasant surprise."

Why You Should Review Beneficiary Designations

Many people neglect to update their beneficiary designations after marriage, divorce, or other changes in their family situation. It's easy to forget to do this and, of course, it involves paperwork—and who likes paperwork?

The problem is this: the beneficiary designation is a legally binding document and it supersedes your will. That means regardless of your current relationship status, and regardless of what your current will says, the asset will go to the person you named in the beneficiary designation whenever you last updated it.

Beneficiary Designations Trump the Will

Some people think an updated will is all you need. Your will or trust will not override what is named in the beneficiary designation on a life insurance policy, annuity, or retirement account (like an IRA or 401(k) plan). The beneficiary designation takes precedence, or as one poker player put it "the beneficiary designation trumps the will." What if you don't name anyone on an IRA account? It is important you update your beneficiary designations to reflect your current wishes so state laws don't determine who receives the benefit. 

Example of Planning Gone Bad

I worked with a client whose wife worked for a large national defense company. It was a second marriage, and when she got ill with serious cancer, she had a trust drawn up. She wanted her two children and husband to each get one-third of her assets. However, she did not update her beneficiary designation with her 401(k) plan and so that sizeable account all went directly to the husband. He wanted to honor her wishes (luckily for the kids from her prior marriage), but if he cashed in the 401(k) and paid it to the kids, he would have to report all the income on his tax return.

He and the kids decided instead to set up an IRA in his name, but with the kids named as the beneficiaries. They agreed that, with each distribution he made to them, he could withhold enough to cover the taxes. This turned out okay but will be an ongoing administrative hassle for years. This type of hassle could have been avoided by updating the retirement plan beneficiary form at the wife's employer. (Note: the employer had no choice—they must follow the beneficiary designation form on file and cannot change the distribution after death even if all parties agree to the change.)

How to Review Beneficiary Designations

Make a list of each retirement account, life insurance policy, and annuity that you have. Add two columns to your list: one for the beneficiary and one for a date. For each account or policy write down the beneficiary and the date it was last updated. In addition to a primary beneficiary, you should also name a contingent beneficiary. This means if the primary beneficiary predeceases you, you have already specified who the account should then go to.

Keep this list in a binder or file folder along with your other important documents. Regardless of any changes, make it a habit of pulling this binder out once a year and reviewing the information in it.

If you need to update a beneficiary, contact the company. They will send you a beneficiary designation form which you will need to fill out, sign, and return to them.

What About a Trust?

Many people establish a revocable living trust, which governs all the assets that are titled in the trust. For example, you could title bank accounts, investment accounts, and real estate in the trust. You are the trustee and control the assets while alive and healthy. The trust document names a successor trustee so if you become incapacitated or die, the successor trustee can easily take over without a lot of administrative hassle.

With an IRA or 401(k), a real person must be the account owner. You cannot re-title the IRA or 401(k) into the trust. You can name the trust as the beneficiary of your IRA, but there can be drawbacks to this. If you have substantial assets in IRAs and other retirement plans, it is best to work with a qualified estate planning attorney to help you figure out the best way to name beneficiaries.