When is the last time you updated your beneficiary designations?
It’s truly amazing the amount of people who have prior spouses or deceased relatives still named as a beneficiary on a retirement account at a former employer, or on a life insurance policy purchased long ago.
That’s why it’s so important that after marriages, divorces, births, deaths and other major life events, account-holders need to check and, if necessary, update beneficiary statements.
Financial advisors say this is one of the most common and potentially costly retirement and estate planning errors that savers and investors make.
“The classic worst case is you get divorced, your [ex-]wife is named as beneficiary and you never change the form,” said Ed Slott, a certified public accountant in Rockville Centre, New York. “You might have changed your will to leave everything to the kids.
“But after you die, your individual retirement account, if it’s never changed, will go to your ex-wife, not the kids.”
Beneficiary forms are 800-pound gorilla when it comes to distributing assets after death.
“Whatever your beneficiary statement says trumps your estate plan,” said Lynn Ballou, a certified financial planner and regional director at EP Wealth Advisors. “It is the go-to document used to distribute assets.”
In 2009, the Supreme Court heard a deceased man’s daughter argue that she, not his long-divorced wife, should get his retirement plan funds. Though the ex-wife had waived her claim to the funds during the divorce, the court ruled unanimously that, because the beneficiary form was never changed to remove her as sole beneficiary, she got it all.
In addition to thinking a will outweighs a beneficiary form, many people fail to check and change beneficiary forms because they regard it as the job of plan custodians or administrators. In fact, plan documents may have the name of a spouse or dependent already filled out as beneficiary. But custodians can make mistakes, warns CFP Katherine Simmonds, partner advisor at AdvicePeriod.
“Don’t let financial institutions, or anyone else for that matter, fill out the forms and then not read the forms before you sign them,” she said. “They could have entered the wrong beneficiary on the form.
“I had a case like that: The financial institution named the trustee of the trust as the beneficiary,” Simmonds added. “That’s a big problem, obviously.”
Beneficiaries for some retirement accounts can be conveniently checked and changed online. For others, account holders need to request the necessary document from the administrator or custodian.
“It is a very simple process to update a beneficiary,” said Mary M. Evans, CFP and senior client advisor with TFC Financial Management. “The custodian of the account or an employer can provide what is usually a very simple form requiring the signature of the account owner.”
Beneficiaries can get more complicated, however. People may name multiple primary or contingent beneficiaries, with a percentage of the funds going to each, or leave funds to trusts or charities. In some states, a spouse’s signed permission is required to name anyone else as primary beneficiary.
“I’ve seen them go on for two pages,” said Richard Baum, a CPA with Anchin Private Client in New York. “So I like to have the legal departments at the institutions approve the beneficiary designation.”
Beneficiary forms should be examined after marriage or divorce of the account holder and any time there is a family birth or death, especially if a beneficiary dies.
Advisors say account-holders who fail make changes after a sole beneficiary’s unexpected death frequently cause beneficiary foul-ups.
“If you have no named beneficiaries, either because you never named them or your beneficiaries pre-decease you, your assets may pass to your estate or be forced to go through probate, which can be a very costly process,” said Michelle Brownstein, CFP, director of private client services at Personal Capital.
“Additionally, if your IRA ends up going to your estate, rather than a named beneficiary, the estate can be forced to withdraw funds and pay the tax on those withdrawals over a fairly short time period,” she added.
The high stakes mean beneficiaries should also be examined occasionally even when nothing has changed.
“It is prudent to periodically, every three to five years, check your beneficiary designations and see if anything should change,” said Travis Sollinger, CFP, senior vice president at Fort Pitt Capital Group.
Advisors say errors can creep in if a plan administrator changes to a new system and fails to carry over a named beneficiary. Sometimes, after mergers, institutions destroy beneficiary forms from predecessor institutions, with a similar result. For that reason, account holders should request and retain copies of beneficiary forms and check that the financial institution’s information matches.
Another time to change beneficiaries is when the account holder changes his or her mind. Sollinger recalls a client who purposely omitted an estranged child from beneficiary designations only to change his mind after she visited him in the hospital. Sollinger helped the client make the change from his hospital bed shortly before he died.
In addition to IRAs of the traditional, Roth, SIMPLE and SEP varieties, beneficiaries should be checked on 401(k) plans, 403(b) and deferred-compensation employer plans, life insurance policies, 529 education accounts and any bank or other account designated as “Transfer on Death.”
Naming beneficiaries is not without risks, limits or costs. Naming a minor child or other person incapable of managing funds is one possible mistake. Giving money to a high earner who is then pushed into a still-higher tax bracket could be another.
The process can be cumbersome when it requires sign-offs from spouses and administrators. If it calls for input from estate attorneys, tax accountants and financial advisors, it can be expensive. But advisors say it is fundamental to a solid estate plan.
“People get daunted by the forms and think they have no choices and powers,” said Ballou at EP Wealth Advisors. “The fact is, you own it, you should decide who it will go to, and you have the power.”
— By Mark Henricks, special to CNBC.com