8 beneficiary designation mistakes to avoid

Designating beneficiaries for your retirement and other financial accounts is important. Doing so outlines how and to whom you want your assets distributed upon your death. And since it’s your responsibility to name your beneficiaries, doing it incorrectly (or not at all) can be costly.

What is a beneficiary?

A beneficiary is a person or organization you name in a legal document to receive a specific financial asset upon your death.

Common accounts like retirement accounts (401(k)s and IRAs), life insurance policies, annuities and bank accounts with Transfer on Death (TOD) designations allow or require you to name a primary and sometimes secondary beneficiary. This designation overrides your will for these accounts, which means it’s the main method for determining who inherits these assets.

Mistakes to avoid when selecting beneficiary designations

Here are eight common mistakes to avoid when selecting and managing beneficiary designations.

1. Not accounting for all your assets.

Before you start determining what and how much you want to go to your beneficiaries, you’ll need a list of all the assets that make up your estate. Be sure to include the following:

• 401(k), 403(b) and other retirement accounts
• IRAs, including traditional, Roth, SIMPLE and SEP
• Life insurance policies (including those provided by your employer)
• Health Savings Accounts (HSAs)
• Bank and brokerage accounts
• 529 education plans
• Investment and mutual fund accounts
• Real estate, including your home and any investment properties
• Business interests
• Personal property

2. Not having a plan.

Once you have a comprehensive list of your assets, do you know where you want them to go upon your death? Your beneficiary designation might be your spouse, your children or grandchildren, your go-to charities or a combination of the above.

You’ll also want to consider whether a trust is a better option for managing and distributing your assets. A trust can be a beneficiary designation and offers many benefits to both grantors and the trust’s beneficiaries.

Naming a living trust as a direct beneficiary of an account allows you to manage your assets during your life. Upon your death, your assets transfer to the trust and distributions are made from the trust to its beneficiaries according to your wishes.

For larger inheritances, a trust can also provide potential tax advantages to beneficiaries.

3. Confusing beneficiary designations and wills.

Many people might think a will is the primary way for determining how someone’s assets are passed on. However, for certain assets transferred using a beneficiary designation (see above), that designation will decide who receives that asset upon your death regardless of what is stated in your will.

4. Missing a beneficiary.

Failing to designate a beneficiary can be a costly mistake. Consider your retirement account: If you haven’t named a beneficiary, the account could get passed to your estate. If this happens, your heirs could be required to take distributions, which they would then be taxed on.

However, if you’ve named your spouse as the beneficiary, they would have the option to roll over funds in a way that defers or minimizes taxes. If you’re philanthropically inclined, naming a charity as a beneficiary of a retirement plan can also be a good tax saving strategy.

Even if you’ve chosen a primary beneficiary for your main accounts, you may want to consider adding a secondary beneficiary in case the primary is not available or declines the inheritance.

5. Not reviewing and updating designations.

With estate planning, it can be tempting to “set it and forget it.” But different life events might call for a review of your beneficiaries, such as becoming a grandparent or getting a divorce.

For example, if one of your beneficiaries dies before you and the designation is never updated, your assets might become part of your estate and may have to go through the legal process called probate. The probate process may mean extra time and additional costs which could have easily been avoided with an updated beneficiary designation.

Some plans may automatically designate your spouse or child as a beneficiary, but you shouldn’t rely on any default provisions in your plan.  Make sure that your designations are current and recheck them annually. Financial institutions and plan administrators are not responsible for your beneficiary designations.

6. Not keeping track of your accounts and documents.

Your plan can be affected by external factors, too. Major changes at the institution administering your retirement accounts or insurance policies – such as a merger or migration to a new system – could affect your designations. Request copies of your plan documents and periodically verify that the documents have matching information and are up to date.

7. Ignoring the financial impact on beneficiaries.

The ability of a beneficiary to handle an influx of money should also be taken into consideration. Receiving an inheritance can occasionally have a negative impact on a beneficiary’s finances.

For example, naming a young adult who is not prepared to manage sudden wealth might result in some unwise short-term decisions and reduce the lifespan of the inheritance.

8. Naming the wrong beneficiary.

Since naming the right beneficiary is important, knowing who you shouldn’t name as beneficiary can also prevent complications and financial challenges. Consider the following:

• Minors under the age of 18 (or 21 in some states) can’t directly inherit assets. A court-appointed guardian may need to manage their inheritance, which may not be in accordance with your wishes. Instead, consider setting up a trust or naming a guardian.
• If you fail to update your designations after a divorce, your ex-spouse could inherit your assets, regardless of your current wishes.
• Disabled individuals receiving government benefits may be disqualified if they receive an inheritance. Setting up a Special Needs Trust (SNT) allows you to name them as beneficiary to your assets and still qualify for outside assistance. 

Choosing and reviewing your beneficiary designations should be a part of your estate planning. Consider working with a financial professional to leverage appropriate trust and estate planning strategies and make sure your priorities are being met in an effective way for you and your beneficiaries.

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