Beneficiary Designation Best Practices

Beneficiary designations determine who receives assets from retirement accounts, life insurance policies, and certain other financial accounts upon the owner's death. These designations operate independently of a will or trust, passing assets directly to named beneficiaries outside the probate process. Because beneficiary designations override estate planning documents, keeping them current and properly structured is essential.

How Beneficiary Designations Work

When an account holder dies, the financial institution or insurance company distributes the asset directly to the named beneficiary. This transfer occurs automatically, typically within weeks, without court involvement or waiting for probate to conclude.

Accounts that commonly use beneficiary designations:

• 401(k) plans and other employer-sponsored retirement plans
• Traditional and Roth IRAs
• Life insurance policies
• Annuities
• Health Savings Accounts (HSAs)
• Payable-on-death (POD) bank accounts
• Transfer-on-death (TOD) brokerage accounts
• 529 education savings plans

The beneficiary designation on file with the account custodian or insurance company controls distribution. Even if a will states that "all my assets go to my children," a retirement account with an ex-spouse named as beneficiary will go to the ex-spouse.

Primary vs. Contingent Beneficiaries

Primary beneficiaries are first in line to receive the asset. If there are multiple primary beneficiaries, each receives their designated percentage.

Contingent beneficiaries (also called secondary or successor beneficiaries) receive the asset only if all primary beneficiaries predecease the account owner or disclaim their inheritance.

For example:

• Primary beneficiary: Spouse (100%)
• Contingent beneficiaries: Child A (50%), Child B (50%)

If the spouse survives the account owner, the spouse receives everything. If the spouse predeceases the account owner, the children each receive 50%.

Always naming contingent beneficiaries prevents the asset from passing through probate if the primary beneficiary dies first.

Per Stirpes vs. Per Capita Distribution

When naming multiple beneficiaries or contingent beneficiaries, the distribution method determines what happens if a beneficiary dies before the account owner.

Per capita means each named beneficiary receives an equal share. If one beneficiary dies, their share is redistributed among the surviving beneficiaries.

Example (per capita): Account owner names three children as equal beneficiaries. One child predeceases the account owner. The two surviving children each receive 50%.

Per stirpes means each branch of the family receives an equal share. If a beneficiary dies, their share passes to their descendants.

Example (per stirpes): Account owner names three children as equal beneficiaries. One child predeceases the account owner but has two children of their own. The two surviving children each receive 33.3%, and the deceased child's two children (the grandchildren) split the remaining 33.3%, receiving 16.67% each.

Per stirpes is generally preferred for family wealth transfer because it ensures assets pass down generational lines rather than shifting sideways to siblings.

Special Considerations for Retirement Accounts

Retirement accounts have additional rules that affect beneficiary planning.

Spousal beneficiaries of IRAs and 401(k)s have unique options:

• Roll the inherited account into their own IRA
• Treat the inherited account as their own
• Take distributions based on their own life expectancy

Non-spouse beneficiaries (under the SECURE Act of 2019 and SECURE 2.0 Act of 2022):

• Most non-spouse beneficiaries must withdraw all funds within 10 years of the original owner's death
• Certain "eligible designated beneficiaries" (minor children of the deceased, disabled individuals, chronically ill individuals, and beneficiaries not more than 10 years younger than the deceased) may use life expectancy distributions
• Minor children must complete the 10-year withdrawal period after reaching age 21

401(k) plans require spousal consent to name a non-spouse primary beneficiary. This protection does not apply to IRAs.

Life Insurance Beneficiary Considerations

Life insurance proceeds pass income-tax-free to beneficiaries. However, they may be included in the deceased's taxable estate if the deceased owned the policy.

Naming a trust as life insurance beneficiary can provide:

• Control over how and when beneficiaries receive funds
• Asset protection for beneficiaries
• Potential estate tax benefits if an irrevocable life insurance trust (ILIT) is used

Avoid naming "my estate" as life insurance beneficiary. This subjects the proceeds to probate, potential creditor claims, and eliminates the privacy benefit of beneficiary-designated transfers.

Worked Example: Updating Beneficiaries After Divorce

David, age 52, recently finalized his divorce after 18 years of marriage. He has two adult children from the marriage. His financial accounts include:

Current beneficiary designations (before update):

Total: $1,300,000 with ex-wife as primary beneficiary on all accounts

David's divorce decree awards him full ownership of his retirement accounts and life insurance. However, the divorce decree does not automatically change beneficiary designations. If David dies without updating these forms, the results depend on state law and plan rules:

• Some states automatically revoke an ex-spouse's beneficiary designation upon divorce
• Federal ERISA-governed plans (like 401(k)s) may follow the designation on file regardless of state law
• The safest approach is to update all designations promptly

Updated beneficiary designations:

Outcome if Child A predeceases David (per stirpes):

Child A has one child (David's grandchild). Under per stirpes distribution:

• Child B receives 50% of each account
• David's grandchild (Child A's child) receives the other 50%

If David had chosen per capita instead, Child B would receive 100% and the grandchild would receive nothing.

Process for updating:

1. 401(k): David contacts his HR department to obtain a beneficiary change form. He completes and returns the form with required signatures.

2. IRAs: David logs into his brokerage account or contacts customer service to update beneficiary designations. Most firms allow online updates.

3. Life Insurance: David contacts the insurance company directly or works through his insurance agent to file a change of beneficiary form.

4. TOD Brokerage: David completes a new TOD registration form with his brokerage firm.

Timeline: All updates completed within two weeks of divorce finalization.

Documentation: David saves confirmation of each beneficiary change and keeps copies with his estate planning documents.

Common Beneficiary Designation Mistakes

Failing to name a beneficiary: The account passes according to the plan's default provisions, often to the estate, subjecting it to probate.

Naming only primary beneficiaries: If all primary beneficiaries predecease the owner, the account may pass to the estate.

Naming minors directly: Minor children cannot legally control assets. The court may appoint a guardian for the funds, creating costs and delays. Consider naming a trust or custodial arrangement.

Not updating after life events: Divorce, death of a beneficiary, birth of children, and marriage all warrant beneficiary review.

Conflicting designations: Multiple beneficiary forms on file can create disputes. Ensure only the most recent form is valid.

Naming a trust without coordination: If you name a trust as beneficiary, ensure the trust is properly drafted to receive retirement assets without adverse tax consequences.

Annual Review Process

Review beneficiary designations at least annually and after any significant life event:

• Marriage or divorce
• Birth or adoption of children
• Death of a beneficiary
• Significant change in financial circumstances
• Change in relationship with a named beneficiary

Keep a master list of all accounts with beneficiary designations, including account numbers, custodians, current designations, and date last reviewed.

Beneficiary Designation Checklist

• List all accounts that use beneficiary designations
• Obtain current beneficiary information from each custodian or insurance company
• Verify primary beneficiaries reflect your current wishes
• Name contingent beneficiaries on every account
• Specify per stirpes distribution for family beneficiaries
• Ensure spousal consent is obtained where required (401(k) plans)
• Update all designations promptly after divorce
• Consider trust beneficiaries for minor children or special needs beneficiaries
• Avoid naming "my estate" as beneficiary
• Save confirmation of all beneficiary changes
• Keep copies of beneficiary designation forms with estate planning documents
• Schedule annual review of all beneficiary designations
• Coordinate beneficiary designations with your overall estate plan