4 beneficiary mistakes to avoid

Building wealth is one thing; making sure the right people have access to the money is another. One of the easiest ways to ensure your hard-earned money goes to the right people is by updating the beneficiary designations on your financial accounts. However, not all accounts are created equally when it comes to beneficiarie, so it’s easy to make small mistakes that could cost your loved ones.

Here are four easy to make (and fix) mistakes we see frequently when it comes to naming beneficiaries.

1. Not updating the beneficiaries on your accounts.

Picture this: You’re working a good job with a solid 401(k) offering. You’re in your twenties and in a serious relationship, so you decide to make your girlfriend the beneficiary on the account. Two years later, you break up. Your ex-girlfriend gets married, you meet someone new, and while you live with her for many years, you never marry. Then, just months before you’re set to retire, you die unexpectedly leaving your siblings to realize that your ex-girlfriend—who you haven’t spoken to in 40 years—is set to inherit the more than $750,000 in your retirement account.

That isn’t a hypothetical. It happened to a man named Jeffrey Rolinson, and a court ruled his ex-girlfriend is indeed entitled to what now amounts to nearly a million dollars, all because he failed to update the beneficiary designation on his retirement accounts.

Avoid this mistake. There are two “best practice” approaches to keeping your beneficiary designations up to date.

• Update your beneficiaries whenever there’s a significant life event, such as a birth, death, marriage, or breakup.
• Review your beneficiaries once a year.

We suggest you review your beneficiaries annually with a professional. While it’s easy to note whether a major life event has taken place, there may be other circumstances you aren’t aware of that an expert can help you navigate. For example, the SECURE act and SECURE Act 2.0 changed some of the rules around how retirement accounts are transferred to spouses and other beneficiaries. A yearly review with a financial professional can help protect you and your loved ones.

2.  Assuming all accounts have the same rules.

Not all financial accounts are created equal. For instance, tax-advantaged retirement accounts such as 401(k)s, 403(b)s, IRAs, and Roth IRAs bypass probate when the account holder dies. This means they aren’t logged into the public record or reviewed by a judge. Plus, spousal beneficiaries may qualify for certain tax advantages under SECURE Act 2.0.

Regular bank accounts (like saving and checking accounts) and taxable brokerage accounts follow different rules. These accounts can sometimes have joint owners, making transfer upon death simple and automatic. In community property states, some accounts may pass to spouses even if it’s a sole-owner account with no beneficiary. (California is a community property state.)

Avoid this mistake. Experts—like estate planning attorneys and financial advisors—can help you understand the rules of transfer where you live. Additionally, they can help you craft both a will and estate plan that work in concert to ensure that your accounts go to the right people.

3.  Not naming a contingency beneficiary.

Even if you’re diligent about maintaining your beneficiaries, you may not be fully protected. Consider an accident where you and the primary beneficiary to your account both die unexpectedly. This type of situation is why many accounts allow you to name a contingent beneficiary—a person who will become the beneficiary of the account if the first beneficiary pre-deceases you or is unwilling to accept the funds.

For instance, a reddit user recently shared that her ex-fiancé, much like the man in our initial example, forgot to update his retirement account beneficiary. She wanted to refuse the funds and give them to his family. If he named a family member as a contingent beneficiary, the process for her will be much smoother and require far less in legal fees.

Avoid this mistake: When applicable, list a name as the contingent beneficiary and keep that field up to date along with the primary beneficiary designation.

4.  Naming a trust as beneficiary.

Trusts are an incredibly useful estate planning tool; they allow you to bypass probate and be much more particular with your wishes and instructions than a basic will. That said, it’s rarely a good idea to name a trust as the beneficiary of qualified accounts. Doing so may lead to expensive complications.

For example—if you have an annuity within your IRA, it should transfer ownership according to IRA rules. Which is to say—spousal transfer should apply and supersede the transfer of assets to a trust. At Reason Financial, we’ve seen the insurance provider refuse to honor these update rules without a lawsuit.

Avoid this mistake: Do not name a trust as the beneficiary to a qualified retirement account. Of course, exceptions apply. We sometimes recommend clients do this if they are unmarried with no children or immediate successor. We do this because these clients often have more complex wishes for how their estate will be distributed upon their deaths. For instance, they may want their funds to go to any living siblings, but not to their children. If you expect your legacy planning to include some form of “is this, then this, but if that, then this” scenario, a trust can help ensure your wishes are met.

Keep your beneficiaries current

We recommend using best practices with regard to your beneficiaries. If there’s a noticeably large event—like a birth or a death—use it as a chance to review your beneficiary designations. Regardless, we suggest you review them once a year with a financial advisor. If the updates are outside of the advisor’s purview, ask them to connect you to an estate planning attorney with experience in your city and state.

If you have questions about what’s covered in this article or general questions about legacy and estate planning, contact us to discuss.