Beneficiaries: Careful what you decide

Nilus Mattive

This post Beneficiaries: Careful what you decide appeared first on Daily Reckoning.

I’ve written about the importance of having a will before. But not everything you own is controlled by a will when you die.

Some of your most valuable assets, for example, life insurance benefits, employer-sponsored retirement plans, IRAs, and annuities allow you to name a beneficiary. And that designation overrides what you have in your will.

Naming a beneficiary on your retirement plan documents or life insurance application is a snap. Fill in the form, and 30 seconds later you’re done.

And when the day comes for your beneficiaries to collect, all they have to do is complete and sign a form, and then send it to the financial institution along with your death certificate.

Since probate is not required, the process is generally fast and doesn’t cost a cent.

You can name individuals, charities, trusts, organizations, or your estate (where it would be distributed according to your will). You could even name a group of individuals, like “all my grandchildren who survive me.”

That stroke of a pen on a simple form focuses on who will receive your assets.

Yet it might not correlate with your overall estate plan, which can lead to mistakes made and problems down the road.

For instance, when…

Naming minors as beneficiaries

If minors receive an inheritance, the court will appoint someone to manage the funds. When the child reaches the age of majority – 18 to 21 depending on the state – they’ll get the money.

Imagine, though, someone at that age coming into a large lump sum, say from a life insurance policy.

I started investing when I was in grade school, so I probably would have bought dividend-paying stocks or tucked the money into some other safe place for future use.

But I know what many of my friends would have done: New cars, expensive clothes, or a trip to Europe!

So if you want minors to receive assets that have a beneficiary form, you might consider drafting a trust first and naming the trust as beneficiary.

The trust could, for example, specify that the children receive payouts at age 25 when there’s a better chance they’ll handle the money wisely.

Worried that an inheritance would make your kid lazy?

As I explained in a separate article, an incentive trust holds the inherited assets on behalf of your beneficiaries. You (the grantor) spell out conditions they must achieve before receiving distributions.

However, it’s important to know there are also…

Risks when naming a trust as beneficiary

Trusts are valuable estate planning tools. Drafting a trust that will be the beneficiary for your assets allows you to select a trustee to distribute those assets to the ultimate beneficiaries (your grandchildren, for instance) per your instructions within the trust.

Plus it could protect the inheritance from creditors.

But in certain circumstances, a trust could also penalize a surviving spouse…

If a surviving spouse is named beneficiary on her deceased husband’s IRA, she can retitle the account as an inherited IRA and remain the beneficiary. Or she can treat it as her own.

In either case, she can defer RMDs until age 70½ when the distributions are taxed at her ordinary income tax bracket.

Such deferral is not always possible if a trust for the benefit of the surviving spouse is named as beneficiary. And the trust may be required to make the payout within as little as five years.

Other potential minefields…

Beware of beneficiary forms that don’t allow your assets to pass “per stirpes,” or equally among the branches of a family.

Suppose you name your three adult children as beneficiaries of your IRA. If one of them predeceases you, you might want that child’s share to go to his or her children.

However, many standard beneficiary forms provide that your two remaining adult children would share the pot. That’s because the insurance company or a financial institution may consider it impractical to determine the identity of such descendants.

Some forms also make it impossible or awkward to designate a trust for distribution to beneficiaries who are minors or someone who is incapacitated. That could require appointment of a guardian or conservator for any such beneficiary.

All too often completing a financial institution’s beneficiary forms is taken lightly without any professional help. The company’s representative is anxious to close the sale before you change your mind or death is something you’d just as soon not even think about.

So pause before filling in that form. How will that asset affect those you hope to pass it to? What are the tax implications?

You want to focus on not only WHO will receive your assets but also how and under what circumstances.

Also remember to review all your beneficiary and contingent designations after experiencing a life-changing event, such as marriage, divorce, or the death or birth of a loved one.

An estate planning attorney can provide the exact language to include on a beneficiary form or draft an attachment. Once you’ve completed the form, insist that the financial institution or insurance company send a confirmation that it’s been accepted.

Financial institutions merge. Records get lost. So be sure to file that confirmation with your other important papers, too.

And if a company ever refuses to accept your beneficiary instructions, I suggest taking your business elsewhere.

To a richer life,

Nilus Mattive
Editor, The Rich Life Roadmap

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