Beneficiary decisions are a crucial yet often overlooked step when planning for retirement. Simply having a will does not mean your estate plan is fully covered.
If you die without a will or your will and 401(k) beneficiary are different, the beneficiary designation overrides the will — and it’s largely irreversible.
This is why it’s important to review your beneficiaries periodically and update if need be, especially when going through a major life change such as marriage, divorce, birth, death or retirement.
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Heath Ledger is a famous example — he died in 2008 before he updated his estate plan to include his daughter, Matilda, leaving everything to his parents and three sisters. Fortunately, his family gave all the money to his daughter.
Still, one never knows, so it’s best to use life events as times to update your beneficiaries.
Here are some things to consider as you review your beneficiaries:
A primary beneficiary is the first recipient if the owner passes. For example, if a husband passes and his wife is the primary beneficiary, then the wife will inherit the asset. A contingent beneficiary comes into play only when the primary is deceased. Think of a contingent beneficiary as the backup to the primary.
In order for a contingent beneficiary to inherit the asset, all of the primary beneficiaries must have predeceased them. For example, if Sarah and Jane are primary beneficiaries, and Luke is the contingent and Sarah passes, Jane is the sole beneficiary. Luke is still the contingent. Luke will become the primary only if Sarah and Jane both pass.
Another essential part of naming beneficiaries is understanding the difference between per stirpes and per capita distribution when a beneficiary dies before the estate owner.
Per stirpes means the inheritance goes to the beneficiary’s descendants (the children, grandchildren of the deceased beneficiary).
Per capita distribution means that the beneficiary’s inheritance is divided equally among the remaining living beneficiaries, instead of passing down to their descendants.
In other words, per stirpes ensures a deceased beneficiary’s share stays in that bloodline, while per capita ensures the surviving listed beneficiaries inherit the asset.
This is important for families with a mixed marriage. Let’s say a husband and wife have children from separate marriages. The husband and wife both pass away, leaving a 401(k) to their contingent beneficiaries, his son Peter and her daughter Beth, split 50/50.
But if Beth is no longer living, under a per capita distribution, Beth’s share goes to Peter. Under a per stirpes distribution, Beth’s share goes to her kids or grandkids, keeping it in her bloodline, and Peter gets the other 50%.
Trusts and beneficiary planning
Trusts can also help with beneficiary planning. Using a trust as a beneficiary can be helpful when beneficiaries are minors, have special needs or may not be financially responsible. A trust specifies how and when assets are distributed so they can be given in stages rather than a lump sum, which can prevent reckless spending.
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A trust can also protect assets from creditors, divorce or legal issues.
However, naming a trust as a beneficiary can be expensive and complicated — it’s not for everyone.
Trusts are also taxed at higher income tax rates than individuals, and trusts can be difficult to change if irrevocable. It’s best to consult with a tax or financial professional beforehand.
There are many benefits of having a proper estate plan, including saving your loved ones from legal and financial headaches in the future. Planning for your primary and contingent beneficiaries, understanding distribution structures and considering a trust are important details when it comes to retirement planning.
A tax or financial professional can help you regularly review your choices and update them as your life changes so that your assets are distributed as intended.
For more information, please email Michael Aloi at maloi@sfr1.com.
Investment advisory and financial planning services are offered through Summit Financial LLC, a SEC Registered Investment Adviser, 4 Campus Drive, Parsippany, NJ 07054. Tel. 973-285-3600. This material is for your information and guidance and is not intended as legal or tax advice. Clients should make all decisions regarding the tax and legal implications of their investments and plans after consulting with their independent tax or legal advisers. Individual investor portfolios must be constructed based on the individual’s financial resources, investment goals, risk tolerance, investment time horizon, tax situation and other relevant factors. Past performance is not a guarantee of future results. The views and opinions expressed in this article are solely those of the author and should not be attributed to Summit Financial LLC. Summit is not responsible for hyperlinks and any external referenced information found in this article.
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