This Is the First Step of Estate Planning, and It Only Takes an Hour to Do

Photo to accompany story about naming estate beneficiaries. Getty Images
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When I was a young financial planner, I asked a recently married couple — let’s call them Jack and Diane — what I thought was a simple question: “Who’s Mary Smith?” 

The silence was deafening.

Jack turned beet red. Then Diane blurted out, “Why would you mention HER? She’s John’s ex-wife! They got divorced two years ago.”

I asked the question because I saw that Mary Smith was the sole beneficiary of Jack’s 401(k) retirement account at work. That account had $500,000 in it — and if Jack were to suddenly die, his ex-wife, Mary, would receive all of it. 

This is a classic mistake and one that is easily remedied, but it takes action.

As we come to the time of year when New Year’s resolutions take center stage, here’s one to add to the list: update your beneficiary designations. This simple task is the gateway drug of estate planning, which I have written about extensively for NextAdvisor.

No one likes to think about death but … well, it’s inevitable. Building wealth takes years of hard work. Take an hour of your time now to make sure you have a say in what happens to it when you’re gone. 

The basic idea behind naming a beneficiary (either a person, entity or charity) is to make the transfer of money upon death quick, easy, and clear. Like a will, thoughtfully considering who will be your beneficiary allows you to have control over how your assets will pass to your heirs. While in most cases a beneficiary is a spouse, a child or another family member, you can also choose a trustee of a trust, an estate or a charity to be a beneficiary.

Which Accounts Require Beneficiary Designations?

The most common accounts that provide for the options of naming the person (or people) who will inherit the account value upon your death are: 

  • Retirement accounts, including:
    • 401(k)
    • 403(b)
    • 457
    • Traditional IRA
    • Roth IRA
  • Pension plans
  • Life insurance policies
  • Annuity contracts
  • Certain non-retirement accounts called “Transfer on Death” or “Payable on Death”

Why Beneficiary Accounts RULE

The biggest advantage of beneficiary-designated accounts is that they avoid the legal probate process. As long as the beneficiaries are properly designated, those named take precedence over even what a will might say. If no named beneficiaries exist on an account (and if the plan documents or custodial agreements do not specifically address who would then be the beneficiary), the account would be subject to probate.

Chocolate, Vanilla, and Strawberry?

Beneficiary designations come in different flavors: primary, contingent and tertiary. Here’s an example of how each flavor “tastes.” Going back to my former clients, Jack’s retirement plan listed his ex-wife as the primary beneficiary of the account. The contingent beneficiaries were his adult children from that first marriage. So if Jack were to die, his ex-wife would be first in line to receive the assets. If she predeceased Jack, his children, as contingent beneficiaries, would be next in line. In naming more than one beneficiary, whether primary or contingent, you have to detail the percentages allocated to each. Jack could have also made a tertiary beneficiary designation — the person who would be the third in line in terms of the distribution of assets.

Who Should Be a Beneficiary?

When considering beneficiaries, consider your family members and their needs. Who will feel a financial impact if you were to die? If you are married and partnered, your spouse will usually be the primary, with children (or their trustees, if they are minors) as contingent. But if you are financially responsible for another relative, that person could be added to the list.

Additionally, in many contracts (and in a will or trust), you can pre-determine how assets might be divvied up for the subsequent generation. Warning! We need to whip out some Latin for this next concept.

Pro Tip

As long as your beneficiaries are properly designated, they’ll take precedence over even what a will might say.

Let’s say Connie has three adult children: Peter, Paul and Mary, who are the primary beneficiaries of her life insurance policy. Each would receive one third of the policy proceeds upon Connie’s death.

What happens if one of her children predeceases Connie? Connie may choose to leave her assets “per stirpes” (translation: “roots”, like the roots of a family tree), which means that if one the adult children dies before she does, his or her share would be divided proportionately among their living beneficiaries. Alternatively, Connie could choose “per capita” (translation: “by heads”), which would mean that if one of the adult children were to die, their share of the inheritance goes back to the estate and gets divided among the other living beneficiaries. So instead of one third each, the surviving adult children would split the life insurance proceeds fifty-fifty and the money would not pass down to the descendants of the deceased child.

Finally, when considering who should be the beneficiary of a particular account, you may also want to consider taxes. For example, the non-spouse beneficiary of a retirement account would have to withdraw — and importantly, pay taxes on the money, within 10 years of the date of death. Conversely, life insurance proceeds are non-taxable to the heir, though they are included in the decedent’s estate for tax purposes. 

How to Add a Beneficiary to Your Accounts

To add beneficiaries to an account, call your provider or look for information on their website. Generally, you’ll need to provide some basic information about your beneficiary, like their full name, date of birth, and Social Security number. But in most cases it’s a quick and easy process — with serious benefits.