A major issue in estate planning is who to name as beneficiaries
on life insurance policies, pension plan accounts, and individual
retirement accounts (IRAs). Often this important decision is given
too little consideration. However, naming beneficiaries can be
complicated and can present estate and income tax consequences to
|When Naming Beneficiaries, Remember to
- Age of beneficiary. Many policies and plans
will not directly transfer assets to minors until a trustee or
guardian is approved by a court.
- Ability of beneficiary to manage assets.
Perhaps a trust set up in the person's name would be better than a
- Pension plans. Unless waived by the spouse in
writing, the law requires a spouse to be the primary beneficiary of
- Naming contingent beneficiaries. Should
something happen to your primary beneficiary, the contingent
beneficiary would receive your assets.
No matter who is designated, the beneficiaries will receive the
death benefit proceeds income tax free. Unlike property disposed of
in a will, if the beneficiary designation form is properly
completed, insurance proceeds do not go through probate.
For many married individuals, a spouse will be the most logical
beneficiary. A trust may be a prudent beneficiary choice, however,
if a surviving spouse would not have the ability to prudently
manage a large sum of money. The trustees (often a legal entity
rather than an individual) would then take charge of managing,
investing, and disbursing the policy proceeds for the benefit of
the surviving spouse.
Be sure to name contingent or secondary beneficiaries. This
means that if the primary beneficiary has died, the insurance
proceeds will go to an individual or trust. If there are no
surviving beneficiaries, then your beneficiary is generally the
"estate of the insured," which means the death benefits end up
being probated and ultimately distributed according to the
instructions of the decedent's last will and testament. If an
individual dies without a valid will (intestate), then the order of
legal beneficiaries to whom assets are distributed is specified by
that state's law.
Pension Plans and IRAs
The law requires that a spouse be the primary beneficiary of a
401(k) or a profit sharing account unless he/she waives that right
in writing. A waiver may make sense in a second marriage -- if a
new spouse is already financially set or if children from a first
marriage are more likely to need the money.
Single people can name whomever they choose. And nonspouse
beneficiaries are now eligible for a tax-free transfer to an
The IRS has also issued regulations that dramatically simplify
the way certain distributions affect IRA owners and their
beneficiaries. Consult your tax professional on how these rule
changes may affect your situation.
Naming Children May Not Be Best
Naming children as beneficiaries may cause unforeseen problems.
For example, insurance companies, pension plans, and retirement
accounts may not pay death benefits to minors. The benefits would
likely be held until they could be made to a court-approved
guardian and/or trustee of a children's trust. A guardian, trust,
or trustee should be named beneficiary to ensure competent
management of the proceeds for the children. By naming a children's
trust as a beneficiary, for example, the proceeds could be invested
and managed by a competent trustee (a person or institution) you
choose. A revocable living trust could also be named as a
beneficiary, which keeps the proceeds out of probate.
Current IRS regulations allow nonspousal beneficiaries to
annuitize retirement plan distributions over the life of the
beneficiary. Check with your employer to find out if this is an
option under your plan prior to naming a child as a beneficiary. A
competent financial professional and tax professional can also
offer guidance as to whether this action may be appropriate for
|Special Tax Considerations
- Life insurance. Benefits are transferred
free of income taxes.
- Pension plans. A nonspouse beneficiary must
report the proceeds as "income with respect to a decedent" but can
transfer them tax free to an IRA.
- IRAs. Beneficiaries must pay income taxes up
to the fully deductible portion of the IRA proceeds and earnings. A
spousal beneficiary may be able to treat the IRA as his or her own
Keep Your Plan Up to Date
When completing overall estate plans and wills, it is imperative
to readjust all beneficiary designations so that your estate plan
accurately reflects your intentions. Remember, outdated beneficiary
designations (e.g., older parents or ex-spouses) could misdirect
the intended flow of an entire estate plan unless changed now.
Also, keep in mind that beneficiaries are paid directly as
named. Thus, beneficiary designations are not governed by the
directions of last wills and testaments.
As is always the case with estate planning, consult with
qualified professionals concerning your particular situation in
order to ensure that your beneficiary designations are in tune with