Avoiding typical beneficiary mistakes with a life insurance policy or retirement plan
A beneficiary is an individual, institution, trustee, or estate which receives, or may become eligible to receive, benefits under a will, insurance policy, retirement plan, trust, annuity, or other contract. Simply put, the objective behind naming a beneficiary is to ensure that your assets will go where you want them to when you die.
So whether you're leaving the proceeds of your life insurance policy to your family, the funds of your retirement accounts to a surviving spouse, looking to avoid probate, or to specifically designate who gets what, how much, and when, the beneficiary is where the rubber meets the road.
However, as simple as it may seem, there are common mistakes people make when it comes to selecting a beneficiary(s) that can be counter-intuitive to what you may have wanted. Here's what you need to know:
1. Naming a minor child as a beneficiary on your life insurance policy
Parents use life insurance to provide for their children in the event that one or both of them die unexpectedly. However, naming a minor child as a beneficiary isn't always the best approach. Life insurance companies won't pay life benefits directly to a minor. If you purchase life insurance for the benefit of your minor children and haven't created a trust or made any legal arrangements for a guardian to manage the money on their behalf, the court will appoint one for you. Instead, it's best to set-up a trust to benefit the child and name the trust as the beneficiary of the policy, or name an adult custodian for the life insurance proceeds under the Uniform Transfers to Minor Act.
2. Not being specific when it comes to naming beneficiaries
If you have specific people, organizations, or even conditions for how your policy or plan's money is to be doled out, then now is the time to put it in writing.
People often make the mistake of not being specific enough when naming beneficiaries. For example, do you have more than one child or children from a previous marriage? Then don't name your beneficiaries simply as my children. Instead, list their legal names and Social Security numbers if you have them. Leaving money to a charitable organization? Then list the organization's name, address, and tax ID number.
3. Not specifying conditions for certain beneficiaries
When naming multiple beneficiaries, be specific about who gets what. Do you want the money from your policy or plan split evenly between your children, or have a certain percentage go to each? Do you want to specify conditions such as how the money is to be spent or distributed? For example, you may want a child to wait until they are 21 and use the money only for educational purposes. By establishing a living trust, you can list out the specific terms and conditions for how your beneficiaries are to receive your assets.
4. Assuming the beneficiaries in your last will and testament will avoid probate
When it comes to estate planning, people traditionally rely on a written will to pass their estate onto their heirs. Unfortunately, a will won't allow the proceeds of your policy or plan to pass directly onto the people you want it to. Instead, the will must first go through probate - an expensive, lengthy process that could take years before the assets are distributed to your heirs.
5. Getting taxed by having a different policy owner, named insured, and beneficiary
As a rule, life insurance death benefits are generally tax-free. However, if you have a life insurance policy that's set up to where one person owns the policy, another is the named insured, and the third is the beneficiary, the death benefit may be considered a taxable gift.
For example, if you are the owner of a life insurance policy on your spouse's life, and list your adult child as the beneficiary, you are effectively creating a gift of the policy's proceeds to your child. In this case, you may be the one subject to taxation if the amount exceeds federal tax limits. In family instances such as this, consult with a financial advisor to decide the best way to structure your life insurance policy to possibly avoid a tax situation.
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