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By Editor, August 3, 2010

You can typically name beneficiaries for a variety of assets, including retirement plans, annuities and life insurance policies.  But naming a beneficiary is not as simple as putting a name on a form; it should involve careful consideration, as the repercussions for your loved ones could be significant.

Out-of-date

If you haven’t reviewed your beneficiary designations recently, it’s possible the designations are no longer appropriate.  Review your designations on a regular basis, ideally annually, and when major life events occur, such as marriage, divorce, birth or death.  The assets are passed outside of legal proceedings and the designation is absolutely binding.  The assignment of assets cannot be superseded, not even by a Will. 

Be Specific

Most beneficiary designation forms allow you to name more than one primary and contingent beneficiary with specified percentage of assets.  Be specific and name each versus naming one trusted relative or friend to distribute the assets for you.  If no beneficiary is named, the assets will be distributed through the probate process, which in the case of a retirement plan, can create adverse tax consequences.

Tax Consequences

With life insurance, the goal is to keep the proceeds out of your estate.  If your spouse doesn’t need the money after you are gone, policies (existing or new) can be structured in various ways to keep life insurance from increasing the value of your estate.  This will be even more apparent next year if the estate tax exemption falls to $1 million.  Life insurance may play a major role in creating taxable estates for those who wouldn’t normally have the issue. This estate tax issue can be avoided in many cases if structured properly. 

Regardless of the beneficiary designation, retirement plans, however, will be includable in the value of the estate.  It is important, though, to make sure the designation is not left blank or that “the estate” is not named as the beneficiary.  In these cases, the retirement assets must be distributed within 5 years or at least as fast as the decedent was receiving required minimum distributions (RMDs), thus triggering a quicker income taxability of the assets in addition to the estate taxability. If your family does not need the funds for living expenses, the goal here is to defer distributions as long as possible, “stretching” the assets over longer life expectancies.  This can be accomplished by naming an individual as beneficiary.

Other considerations

To avoid taxable distributions altogether, you could donate your retirement plan to a charity if other assets are available to provide for your family.  Not only will the organization receive the assets tax-free, but your estate will also be eligible for a charitable deduction.

You can name almost anyone as your beneficiary, including individuals, charities and trusts, but minor children, however, cannot be named beneficiaries of life insurance policies, retirement plans or annuities. Additionally, if you are considering designating a special-needs person as your beneficiary, it may hinder the individual’s eligibility for government provided benefits.

There are various ways to still provide for those you want to benefit after you are gone, but with careful planning with an accredited estate planner.