We know that filling out forms and thinking about estate planning isn't exactly how you want to spend your weekend. It’s completely normal to feel a little overwhelmed by the legal terminology, but taking the time to name your beneficiaries is actually a profound act of care for your loved ones. By making these decisions now, you are saving your family from confusion and stress further down the road.
What exactly is a beneficiary?
If we look at the dictionary, Merriam-Webster defines a beneficiary as “a person or thing that receives help or an advantage from something.” That is a great place to start.
In the context of your financial roadmap, a beneficiary is simply the person, organization, or entity you designate to receive the benefits of your assets. This usually happens through an inheritance.
While we often associate beneficiaries with formal estate planning and wills, you will actually encounter this term much more frequently. You are asked to name a beneficiary whenever you open a bank account, sign up for a retirement plan, or buy a life insurance policy.
How to name your beneficiaries
The process is usually straightforward. When you open an account or buy a policy, you will be asked to list who should receive the assets.
The good news is that you have flexibility here. You aren't limited to just one person. If you list more than one beneficiary, you can divide the assets in two main ways:
- By percentage: You might instruct the account to "give 50% to each beneficiary."
- By dollar amount: You could say "give the first $10k to Person X and the remainder to Person Y."
In most cases, you can change these designations whenever you want. The main exception is some life insurance policies that have "irrevocable beneficiaries," which means they cannot be easily removed.
Why designations override your will
This is one of the most important concepts to understand in financial planning. When you name a beneficiary on a specific account, that designation generally overrides your estate planning documents.
Here is a common scenario where this matters. Imagine that following a divorce, you update your will to ensure your money goes to your kids. However, if you don't update the specific beneficiary designations on your accounts to name your kids as well, your life insurance, IRA, and other assets will still go to your ex-spouse. The beneficiary election trumps the will.
Special rules for minors and contingent beneficiaries
Life rarely goes exactly according to plan, so it helps to have backup options. In estate planning, you can name "contingent" beneficiaries. This means if your primary choice has died or can't be found, the money goes to someone else or is divided among others.
It is also common to leave money to a relative with the instruction that if they predecease you, the assets should go to that relative's children.
Handling assets for minors
If you have children, you need to be careful about naming them directly. Minors are generally not eligible to directly receive assets. If you name a minor as a beneficiary, a court-appointed person known as a conservator must usually claim and manage the money until the minor turns 18.
A smoother solution is often having an attorney create a trust to manage the minor's care and leaving the assets to that trust instead.
Common mistakes to avoid
Being named a beneficiary sounds like a strictly positive thing, but it can have unintended consequences. It is always a prudent move to review your choices with a CFP® professional, accountant, or attorney.
Here are a few specific pitfalls to watch out for:
- Government benefits: A disabled person receiving government benefits might lose their eligibility if they inherit money directly.
- Creditor issues: If a beneficiary has financial trouble, the inherited assets could be lost to their creditors.
- Financial aid: College students with need-based scholarships could lose that funding if they receive an inheritance.
- Typos and names: Even a minor typo or a name change due to marriage or divorce can significantly delay the inheritance process.
Finally, the biggest mistake is not naming anyone at all. If you don't name a beneficiary, the state will distribute those assets upon death. This process can take months or even years, and depending on state laws, your assets could go to people you wouldn't have chosen.
What to do if you inherit assets
If you find yourself on the receiving end as a beneficiary, your first step should be consulting a tax professional. Some assets pass to you with little to no taxes, while others bring significant tax bills.
The "Step-Up" in basis
Real estate often gets favorable treatment. For example, let's say your parents bought a home many years ago for $100,000 and left it to you in their will. When they pass away, the home is worth $500,000.
For tax purposes, the home is valued at that $500,000 mark when you inherit it. This is called the "basis." This means capital gains taxes are calculated using that $500,000 figure when you sell, not the original $100,000 price. This same process occurs for most investment accounts, but other assets may be treated differently by tax authorities.
The Facet Difference
Navigating beneficiary designations and estate planning can feel complex, but you don't have to do it alone. At Facet, we believe expert financial advice should be accessible to everyone, not just the ultra-wealthy. Our membership model gives you access to a team of experts, including a dedicated CFP® professional, who can help you integrate these decisions into your broader financial life. We don't charge asset-based fees, so our advice is objective and focused entirely on helping you live well today while planning for tomorrow.
