5 mistakes to avoid when deciding who should be your beneficiary
Estate, Gift, & Trust Planning
Chances are you have a beneficiary. They are pretty common, from retirement accounts to trusts to wills. And they figure prominently in life insurance policies.
Simply put, a beneficiary is the person (or legal entity) that will receive the proceeds from a financial vehicle once the owner passes. So, they typically tend to get named every time an account is opened or policy purchased.
But just as common are certain mistakes that get made around beneficiary designations. Here are five that financial professionals like to warn people about when they decide who should be their beneficiary.
1. Updates and divorce distraction
Updating beneficiaries should be a regular part of any financial wellness routine. But sometimes, it gets forgotten. More often than not, that's what happens during the emotional strife of a divorce case.
Some states have statutes that automatically terminate the beneficiary status of a former spouse after the marriage has been dissolved; other states do not. Make sure to review your life insurance designations after the divorce is final.
2. Is the beneficiary benefiting?
On the surface, leaving money to somebody would generally be considered a good thing. But there are cases when deciding on who should be your beneficiary where, financially, it may not be a good thing for them.
Similarly, leaving a sum of money by making them a direct beneficiary can also affect the kind of support someone can get from other areas. For example, designating a special-needs individual as the recipient of a large benefit could disqualify them from receiving government support. Or, if someone is on Medicaid, they would have to exit the program until they spend down a significant inheritance or death benefit.
Financial professionals can often help lay out alternatives for evaluating how to help someone through a beneficiary designation without sacrificing the availability of government benefits or programs.
3. Estate planning and thresholds
Some estate financial planning situations are straightforward. For instance, a single-person beneficiary of a life insurance policy can receive the death benefit tax-free. Or a retirement account can be turned directly over to a designated surviving spouse.
But often, families and personal situations are a little more complicated. Or there is a desire to distribute assets differently. But a life insurance death benefit paid to an estate can trigger tax and probate issues, not to mention become attachable by creditors. Add in retirement accounts and other financial assets, and the financial implications can get more complicated still, particularly if the assets exceed the $12.92 million exemption (2023) for federal estate taxes or any state tax thresholds.
So, depending on individual circumstances, many people turn to a financial professional to help navigate some of the implications of naming beneficiaries one way versus another. And, through an ongoing relationship, a financial professional can help keep you apprised of federal and state changes that may affect financial plans.
4. Careful with kids
There is a temptation to name children as beneficiaries, especially for life insurance policies. After all, if you are gone, you want to make sure your progeny have the wherewithal to move on.
But here, too, are potentially negative consequences if not planned in a careful way. One basic issue is that while an 18- or 21-year-old (depending on the state) can inherit a benefit directly, they often don’t know what to do with a sudden, large sum of money. And a younger child will require legal oversight. A trust situation may be a solution.
Not having a plan and assuming family will step in isn’t a secure answer, financial professionals caution.
If you have a child with special needs, experts suggest that it is vital to have a special-needs trust. Mistakenly, people leave money to another family member with the understanding that they will care for the child. Unfortunately, that isn’t always the case, and the beneficiary may use some or all the funds for the care of their own children.
5. Let the family know
Communication, more precisely, lack of it, can also be a problem.
Not letting family or loved ones know that you are making them a beneficiary may prevent them from warning you about potential problems — like a tax bill — or about opportunities for a more meaningful legacy — like the preference for a family heirloom versus money. Communication can also head off ugliness.
These are just some of the basic, more common mistakes and challenges that can arise out of beneficiary designations. Obviously, there can be more, often depending on the complexity of individual circumstances. And often what started out as a simple situation can change.
As time goes by and financial assets hopefully grow, the question of who is beneficiary to what and how everything ties together can become more and more complex. Financial professionals can help navigate such circumstances and provide guidance on how to avoid the pitfalls.
The information provided is not written or intended as specific tax or legal advice. Lenox Advisors, Inc. (Lenox), its employees and representatives are not authorized to give tax or legal advice. You are encouraged to seek advice from your own tax or legal counsel. Opinions expressed by those interviewed are their own and do not necessarily represent the views of Lenox Advisors.
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