Benefit of Naming Beneficiaries

By Karyn Koenig

It is never an easy topic to discuss what will happen to us when we are gone. But sometimes it is the simplest aspects of planning for our loved ones that can be the most beneficial.

Selecting beneficiaries to your investment accounts, particularly your IRA or 401k, can have a positive impact on your family after you die. There are several common misunderstandings that people have about selecting beneficiaries.

For example, did you know that the beneficiary form that you filled out (sometimes decades ago) supersedes any will you have prepared? No matter how recent the will is, beneficiary forms still trump it in court. This means someone you may not want to receive your IRA would receive it, such as an ex-spouse. The last thing that you want for your loved ones is a lengthy court battle and costs as they try to recover your assets from a beneficiary who is not current.

If you live in a communal property state, your IRA will automatically go to your spouse. If for some reason you do not want that to happen, you need a notarized release signed by your spouse allowing you to designate another beneficiary. This could be important if you have remarried later in life. If your new spouse is financially stable, you may want to have them sign a waiver and name your children from a previous marriage as your beneficiaries.

Another common misconception is that your estate will handle the distribution of your IRA or 401k. Any type of tax-deferred account will continue to grow tax-deferred if you do not include them in your will or estate. By including them in your estate, these assets will be liquidated and subject to taxation. By selecting a beneficiary, you can essentially roll-over those funds into an account for your beneficiary.

If your spouse is your beneficiary and is in or close to retirement age, those funds will continue to provide for him/her at the reduced taxable rate when they withdraw. If you instead select your child, he or she can choose two methods to receive your IRA. They can choose a full payment, which will be fully taxable, and the taxes must be paid within five years of your death. Or they can take a mandatory withdrawal that will be calculated based on their estimated life span. This means they will only have to pay taxes on the amount that they receive each year.

It is also important that you have your contingent beneficiaries assigned. It may seem redundant, but in the event that you and your spouse pass away at the same time, this could protect your children from paying unnecessary estate tax. Make a copy of beneficiary forms you have filed and give a copy to your chosen beneficiary.

Finally (and most importantly) be sure to look at your beneficiary choices periodically to make sure they are up-to-date.