estate planning

These 2 Words Could Send Your Retirement Money to the Wrong Beneficiary

"Per stirpes" vs. "per capita." Making the wrong choice could cause an estate planning disaster.

Planning for your death may feel slightly morbid and uncomfortable. But the alternative option — ignoring estate planning and beneficiary designations — could end up infinitely worse.

One little-known election on your retirement accounts, the choice of  per stirpes vs. per capita, could even send your retirement money to the wrong beneficiary or cut someone you love out of receiving anything at all. Now that’s uncomfortable.

I recently shared on the Stay Wealthy Retirement Podcast that you won’t be around to see this calamity unfold, but the bitter fallout is something your family will likely never forget.

Beneficiary Planning and Why It Matters

The reality is, you’re alive now ... but you won’t be forever. If you want your money to be inherited by the right people, there are important steps you must take today — before it’s too late. As dark and dreary as it might feel, planning for your death is a thoughtful exercise that will minimize stress on your family when you die.

One important step is making sure the beneficiary designations on your retirement accounts align with your goals and desires. These designations determine who gets your money when you pass away. For the purpose of this article, I’m focusing on retirement accounts like your 401(k), 403(b), traditional IRA and Roth IRA, among others.

Take note: Investments held outside your retirement accounts will be distributed based on other estate planning tools, like a living trust, will or transfer on death (TOD). It’s important to make sure these tools are in place as well since, if you don’t do anything, your estate could go through probate. Probate is expensive, time consuming and something I don’t wish on anyone.

When it comes to retirement accounts, here’s what you should know.

How Per Stirpes Changes the Way Retirement Accounts Are Distributed Upon Death

Most married people choose their spouse as the primary beneficiary on their retirement accounts. This is so common, in fact, that if you don’t choose your spouse as a primary beneficiary, he or she may need to complete additional paperwork to solidify that decision.

After selecting a primary beneficiary, your next step is to set up contingent beneficiaries.

Married with kids? Your contingent beneficiaries might be your children. If you’re not married or you don’t have kids, your contingent beneficiary could be anyone — a niece, a nephew or even your living trust.

Once your beneficiary designations are established, the next step is deciding between per stirpes or per capita. Unfortunately, this step is often missed, mostly because it’s not a requirement on beneficiary designation forms or account applications.

What is per stirpes? This Latin legal term means that, if your primary beneficiary dies before you die, their next of kin inherits your money.

The alternative is known as per capita. By choosing per capita, you are ensuring your money goes to your primary beneficiaries only.

How a Grandmother’s Final Wishes Could Go Awry

Here’s an example of how per capita might work.

Imagine a grandmother, her daughter and granddaughter, who are all alive and thriving. The daughter is the primary beneficiary on the grandmother’s retirement account. Like many retirement savers, the grandmother forgot to name a contingent.

Now imagine the unthinkable happens, and the daughter dies before the grandmother. Years go on and the daughter is still listed as the primary beneficiary when the grandmother passes away.

In this situation, with per capita selected, the money wouldn’t go to the granddaughter. Without additional estate planning and a contingent beneficiary listed, the money would likely go through probate. The court would ultimately decide who inherits the money.

If the grandmother had selected per stirpes, the money would have gone straight to the granddaughter, even if she wasn’t listed as a contingent beneficiary.

In summary, when you choose per stirpes, you ensure that the next of kin to your primary beneficiary (or your heir’s heirs) receive their share of your money.

Now let’s look at a slightly more complex situation with similarly dire results. Imagine the same grandmother, but now she has a daughter and a son, in addition to the granddaughter. The daughter and son are listed as 50/50 primary beneficiaries on the grandmother’s $1 million retirement account.

If the daughter predeceases everyone and the grandmother failed to select per stirpes, the entire $1 million inheritance would go to the son when she passes. The granddaughter would be entitled to nothing.

This is how per capita works. Per capita ensures your money goes to your primary beneficiaries only. And, per capita is typically the default option most retirement savers have in place right now.

Depending on how you want your inheritance handled, it’s easy to see how this could be a costly estate planning mistake.

The Bottom Line

Maybe you’re fine with per capita being the default option on your retirement accounts, and that’s perfectly OK. But if you’re not, now is the time to review this important designation and consider making a change.

Fortunately, this is an easy process. All you have to do is contact your financial planner or the financial institution where your retirement accounts are held and request a copy of your current beneficiary designations. From there, you can confirm if what you currently have on file is what you want and make any necessary changes.

Depending on where your accounts are held, you may even be able to make these important changes online. Either way, don’t let this slip through the cracks. Your heirs could easily be left in the cold without careful planning.

About the Author

Taylor Schulte, CFP

Founder and CEO, Define Financial

Taylor Schulte, CFP®, is founder and CEO of Define Financial, a fee-only wealth management firm in San Diego. In addition, Schulte hosts The Stay Wealthy Retirement Podcast, teaching people how to reduce taxes, invest smarter, and make work optional. He has been recognized as a top 40 Under 40 adviser by InvestmentNews and one of the top 100 most influential advisers by Investopedia.

Most Popular

The Best Stocks for a Bear Market
stocks to buy

The Best Stocks for a Bear Market

The ideal bear-market stock pick should have a defensive business, a long history of dividend growth and relatively low volatility. Here are 10 stocks…
May 18, 2022
Your Guide to Roth Conversions
Special Report
Tax Breaks

Your Guide to Roth Conversions

A Kiplinger Special Report
February 25, 2021
15 Stocks Warren Buffett Is Buying (And 7 He's Selling)
stocks

15 Stocks Warren Buffett Is Buying (And 7 He's Selling)

Berkshire Hathaway CEO Warren Buffett is a bull once more! The Oracle and his team entered eight new positions and added to others in a big way.
May 17, 2022

Recommended

What’s a DST? The Lowdown for Real Estate Investors
real estate investing

What’s a DST? The Lowdown for Real Estate Investors

Delaware Statutory Trusts can potentially solve a lot of problems for real estate investors and those considering a 1031 exchange in this hot market. …
May 22, 2022
Don’t Move to Another State Just to Reduce Your Taxes
retirement

Don’t Move to Another State Just to Reduce Your Taxes

If you’re retired or near retirement, maybe a smarter plan for retirement income will allow you to stay put. Yes, your state income tax rate may be hi…
May 21, 2022
COVID’s Financial Toll Isn’t What You Think
Coronavirus and Your Money

COVID’s Financial Toll Isn’t What You Think

From a grandma’s retirement in ruins to a troubled teen inheriting too soon, COVID’s effects will last for generations. While nothing can prepare you …
May 21, 2022
Medical Professionals: It’s Not Too Late to Save on Your Taxes
tax planning

Medical Professionals: It’s Not Too Late to Save on Your Taxes

If your income rebounded in 2021, consider these four investment and tax-saving moves now. While most of these strategies apply to 2022 and beyond, on…
May 20, 2022