Naming a beneficiary is an essential step in estate planning that allows individuals to determine how their estate will be distributed in the event of death.
By understanding the different types of beneficiaries and the importance of naming them, individuals can ensure that their estate is passed on to loved ones or causes that are important to them.
Read everything you need to know about beneficiaries.
What is a Beneficiary?
A beneficiary is a person or entity legally designated to receive the benefits or proceeds from a trust, will, insurance policy or retirement account.
A beneficiary’s specific rights and responsibilities will depend on the type of instrument, which may include:
- A trust: Trusts are legal arrangements in which grantors transfer property to trustees, administered for the benefit of the beneficiary. The trustee is legally obligated to manage the estate and distribute the income to the beneficiary in accordance with the terms of the trust agreement.
- An insurance policy: The beneficiary can be a person, such as a spouse or child, or an entity, such as a charity or living fund. The death benefit is paid tax-free to the designated beneficiary and can be used to cover expenses such as funeral costs, outstanding debts or financial security.
- A will or estate: The person who writes the will, the testator, can specify who the beneficiaries will be and how much each will receive. If the testator dies without a will, the estate will be distributed according to the laws of the state where he lived.
- A Retirement Account: An IRA or 401(k) account will provide the beneficiary with the remaining account balance in the event of the account holder’s death.
- A bank account: Financial accounts, such as savings accounts, checking accounts, and certificates of deposit, can be held in either pay-on-death (POD) or transfer-on-death (TOD) designation. This allows individuals to name the beneficiaries who will receive the funds in the account upon death without going through the probate court.
- Investment Accounts: Investment accounts such as brokerage accounts can be held in the TOD designation. This allows individuals to name the beneficiaries who will receive the assets in the account upon death without going through the probate court.
- Real estate: Real estate can be held under a joint lease with the right of designation of survivorship, which allows the surviving tenant to inherit the property in the event of the death of the other solidary tenant.
Related: What is a trust fund and how do they work?
In addition, different types of beneficiaries include:
- Primary beneficiary: The primary beneficiary is the person or organization that receives benefits first. If the primary beneficiary dies before the owner, the secondary beneficiary will receive benefits.
- Secondary beneficiary: The secondary beneficiary is the person or organization that receives benefits if the primary beneficiary predeceases the owner of the asset.
- Contingent beneficiary: The contingent beneficiary is the person or organization that will receive benefits if the primary and secondary beneficiaries die.
- Beneficiary by Lineage: The lineage designation is a way of specifying how benefits will be distributed if the primary beneficiary dies before the owner of the asset. With a per stirpes designation, benefits will be distributed to descendants of the principal beneficiary.
- Per capita beneficiary: The per capita designation specifies how benefits will be distributed if the primary beneficiary dies before the asset owner. With per capita designation, the benefits will be distributed equally among the descendants of the primary.
- Beneficiary Totten Trust: A Totten Trust is a type of savings account used to pass on small amounts of money to a named beneficiary upon the death of the account holder.
- Charitable Beneficiary: A charitable beneficiary is a non-profit organization that will receive the benefits of the asset upon the owner’s death.
- Special needs beneficiary: A special needs beneficiary is a person with a disability who will receive the benefits of the property after the owner’s death. Benefits can provide financial support while preserving an individual’s eligibility for government benefits.
- Business Entities: Business entities such as partnerships and corporations can be named as beneficiaries. This can be useful for individuals who own a business and want to ensure its continuity after death.
Related: 4 Succession Planning Lessons for Entrepreneurs
What if a person fails to name a beneficiary?
If an individual does not name a beneficiary, the distribution of his assets will be determined by the laws of the state in which he lives.
This means that assets will be distributed according to state laws, which normally prioritize family members such as spouse, children and other close relatives. If the individual has no relatives, his assets can be distributed to the State. Failure to name a beneficiary may also result in the loss of certain benefits and protections.
For example, if an individual has a retirement account but does not name a beneficiary, the assets may not be eligible for a tax-free transfer to the surviving spouse.
Related: Everything you need to know about a retirement plan
What are 5 reasons people assign beneficiaries?
1. Estate planning
Estate planning involves making arrangements for the distribution of property after death. By designating beneficiaries for their assets, individuals can ensure that their property is distributed according to their wishes, avoid probate and minimize inheritance taxes.
Probate is a court-supervised process used to settle a deceased person’s estate, which can be time-consuming and expensive. Minimizing estate taxes can help ensure that more of the deceased person’s estate passes to their beneficiaries rather than being lost to taxes.
Related: Why is estate planning more important now than ever?
2. Insurance planning
Insurance planning involves making arrangements to provide financial protection to loved ones in the event of death. By designating insurance coverage beneficiaries, individuals can ensure that their loved ones receive the policy’s death benefit immediately.
The death benefit can cover expenses such as funeral costs or outstanding debts or provide financial security to the beneficiary.
Related: Busy Parents: Sign Up for Life Insurance With This Quick Provider
3. Retirement planning
Retirement planning involves making arrangements for financial security after retirement. By designating retirement account beneficiaries, individuals can ensure that their loved ones receive the remaining account balance upon their death.
The remaining account balance can be used to provide the beneficiary with financial security, such as helping to pay living expenses or education costs.
Related: What is a pension? Types, benefits and more
4. Charitable donations
By designating a charitable organization as a beneficiary, individuals can make a lasting impact and support a cause they care about.
5. Special needs planning
Special needs planning involves making arrangements for the financial security of a family member with special needs.
By designating a person with special needs as the beneficiary of their estate, individuals can provide for their beneficiary while still preserving their eligibility for government benefits.
Related: Why Disabled Business Executives Should Take Back Control of Their Health Care Now
What should you consider when naming a beneficiary?
- Purpose: Is it to provide for a loved one, support a charitable organization, or fulfill a specific need or obligation? Knowing the objective can help guide the decision-making process.
- Estate Planning Goals: Consider the individual’s estate planning goals, such as tax planning, creditor protection, or probate prevention, as these goals may affect beneficiary choice.
- Age and health: Consider the age and health of potential beneficiaries, as younger beneficiaries may need the assets for a longer period. In comparison, older beneficiaries may have more immediate needs.
- Family dynamics: It is essential to consider who might need the goods the most and who would be the best caregiver for minor children.
- Reliability: Will the beneficiaries be responsible for the assets and will they use them as intended?
- Flexibility: Can the designation be changed in the future if circumstances change?
Related: Retirement Savings Annuity Options – No Confusion, No Jargon, No Tricks
How do you name a beneficiary?
The beneficiary nomination process varies depending on the type of asset being considered, but generally involves a step-by-step process similar to this:
- Review terms and conditions: Before naming a designated beneficiary, it is crucial to understand the terms and conditions of the asset with the help of a financial advisor. For example, the process for naming life insurance beneficiaries will differ from the process for naming a beneficiary for a retirement account.
- Identify potential beneficiaries: After reviewing the terms and conditions, identify potential beneficiaries such as family, friends or charitable organizations.
- Choose the appropriate form of beneficiary designation: The appropriate form of beneficiary designation will depend on the type of asset. For example, life insurance companies often require a written designation on the life insurance policy, while retirement accounts may allow for an electronic designation.
- Complete and Sign the Beneficiary Designation Form: Once you have chosen the appropriate Beneficiary Designation Form, you will need to complete and sign the form. This may involve providing legal documents, such as a CPF and birth certificate, to designated beneficiaries.
- Send the completed form to the appropriate party: The completed form should be sent to the relevant party, such as the insurance company or the pension plan administrator.
- Review and update your beneficiary designations regularly: It is essential to review and update your beneficiary designations regularly to ensure they are current and reflect your current wishes. Major life events, such as the birth of a child, the death of a spouse, or a spouse who becomes an ex-spouse, may require you to update your beneficiary designations.
What do you need to know about beneficiaries?
Beneficiaries play a crucial role in the distribution of assets after an individual’s death. When naming a beneficiary, it is vital to consider the different types of beneficiaries, the specific circumstances and the individual’s goals.
By understanding the importance of naming beneficiaries, individuals can ensure that their estate passes on to their loved ones and the causes that matter most to them.
If you are looking for additional information about personal finances, real estate planning and more, visit Entrepreneur.com.