For many of you, the bulk of the estate ("stuff") that you will be passing on to your loved ones is controlled not by your will, a trust or the probate court, but by the beneficiaries you designated on forms filed with financial institutions. 401(k)'s, IRAs, and Life Insurance policies will be distributed at your death based on whom you have chosen as a beneficiary.
Based on my conversations with clients, I'm betting that many of you have not checked those designations in a very long time - if ever.
What can happen if you name the wrong beneficiary or No beneficiary?
First, let's talk about what may happen if you name no beneficiary. If you do not name a beneficiary for a life insurance policy, after your death an estate will have to be opened to receive the money from that policy. That means that your family will not receive money from your life insurance policy until a petition is filed in the probate court. If you intended for the proceeds of your life insurance to be distributed based on your will, that will work. However, if you die intestate (without a will), the state's plan controls where those proceeds will go.
If you don't name a beneficiary on a tax qualified plan such as an IRA or 401(k), an unintended beneficiary may get the proceeds and the IRS may get more from your 401(k) or IRA then if you had named beneficiaries.
IRA's and 401(k)'s are controlled by a "contract" with a plan administrator or custodian. At the death of the account holder, distributions are made based on the terms of that contract. Generally, the terms of that contract are that if no beneficiary is named, the administrator or custodian is required to pay the IRA or 401(k) proceeds to the estate of the account holder within one to five years.
Remember that when a tax qualified plan (not including Roth IRAs) is distributed, there may be a tax liability to the person receiving those funds. For example, if the IRA is $100,000 and is distributed to one individual in a single year, that person's taxable income has increased by $100,000 increasing his or her tax liability significantly for the year of distribution.
What happens if the wrong beneficiary is named?
This can happen when people marry, divorce, or have children without changing the original beneficiary designation forms. For example, if Jane establishes her IRA at the local bank, names her mother, Sue, as the beneficiary, and then marries Frank and has two children after her marriage without changing her IRA beneficiary designation form. Who do you think will get the IRA proceeds in the event Jane forgets to change the beneficiary designations? Most likely Sue will receive those proceeds.
What if Sue precedes Jane in death? Who gets the proceeds then?
This can happen when people marry, divorce, or have children without changing the original beneficiary designation forms. For example, if Jane establishes her IRA at the local bank, names her mother, Sue, as the beneficiary, and then marries Frank and has two children after her marriage without changing her IRA beneficiary designation form. Who do you think will get the IRA proceeds in the event Jane forgets to change the beneficiary designations? Most likely Sue will receive those proceeds.
When should you check your beneficiary designations?
I recommend that you check them regularly, but make sure to check after marriage, divorce, birth of children, death of any loved one, and every time you update your estate plan!