Why Review Beneficiary Designations Annually

Retirement planning is a long process. When you first start trying to secure your retirement, your life may be entirely different than it is today. One topic that we’re passionate about is the need to review beneficiary designations annually.

Backtracking a little bit, we decided to discuss this topic in-depth with you after reading an article on MarketWatch.

The story begins with a man who has a market account worth around $80,000. Suddenly, this man passes away, and the beneficiary of his account is his prior wife. However, his prior wife was deceased.

What Happens if the Beneficiary of an Account is Deceased?

In the scenario above, the man’s prior wife is deceased already. When he passes on, the account then goes to his estate. His account must then go through probate and into the estate, too.

However, in this man’s case, he had a daughter who was meant to inherit the account. Her stepmother even sent the daughter a text message stating that her father wanted her to have the money in the account.

Fast forward a bit, the stepmother becomes the executor of the estate after the account goes through probate and says, “She thinks the girl’s father changed his mind and that the money is meant to go to her, the stepmother.”

The daughter feels like the stepmother betrayed her father.

Unfortunately, a text message isn’t enough legal grounds for the daughter to fight back against her stepmom.

This is an example of someone who didn’t review beneficiary designations annually. Instead of the father’s wishes being upheld, someone else decided what they thought was best for the funds in the account.

Key Takeaways from this Example

Beneficiary designations are very important. We don’t know what the father wanted to happen to the funds in his account, nor do we know what may have been written in his estate plan. What we do know is that the daughter does have a message from her stepmother stating that the funds were meant for her, but something changed along the way.

We can speculate that perhaps the stepmom found estate documents mentioning that she received the estate, or maybe she fell on hard times financially and wanted to keep the funds.

In all cases, this could have been avoided by:

  • Reviewing beneficiaries annually
  • Updating beneficiaries when major life changes occur

Many accounts that you have often allow you to add beneficiaries, even if you don’t know that you can. For example, you can add beneficiaries to IRA, 401(k) and life insurance. You can even add beneficiaries to checking accounts.

We recommend that you:

  • Gather all of the accounts that have money in them
  • Inquire with all of these accounts if you can add a beneficiary

Probate and state law can vary from state to state dramatically. The daughter in the case above wanted to know if she could use the text message as evidence and file a lawsuit.

Contesting Probate 101

We don’t know the logistics of the case the daughter has or if a text message will mean anything in her scenario. Likely, the text will not hold up in court. What we are certain of is that contesting probate is:

  1. Lengthy and can be very difficult to do
  2. Costly

Avoiding any probate contestation is always in your best interest. The father in the example above may have been able to add a contingent beneficiary to his account. What this does is say, “If the first person is no longer living, the next beneficiary should be this person.”

Contingent designations would have helped this family avoid probate court and animosity between the daughter and stepmom.

7 Steps to Manage Your Beneficiaries Throughout Your Life

1. Review Your Beneficiaries Annually

For our clients, we do a beneficiary review each year. We show them who is listed on their accounts as a beneficiary, including:

  • Beneficiary name
  • Percentage to each beneficiary
  • Contingents
  • Etc.

If you’re not a client of ours, you can easily do this review on your own. Reach out to all of your account holders and ask them who you have listed on your account as a beneficiary. It is possible that you sent in a form to change a beneficiary and it was never filed.

It’s so important to verify your beneficiaries annually, even if you have a form sitting in front of you naming the beneficiary, because you just want that peace of mind that everything has been filed properly.

2. Consider Tax Implications

When you leave accounts behind, they may have certain tax implications that you need to worry about. For example, an IRA is taxed one way and a Roth IRA is taxed another way. It’s important to know the implication of each account to make it easier to understand who best to leave the account to when you pass.

If you leave an account to a high-income earner, they may take the money out of the account and pay the tax burden. Then, they may decide to give the money to your grandkids.

However, there are ways that you can set up these accounts to avoid this high tax burden and leave the funds to your grandkids directly. You can do what is known as “disclaiming,” which would allow your son or daughter to divide the money how they see fit with fewer potential taxes.

3. Understand the Impact on Your Overall Estate Plan

Let’s assume that you’re leaving $1 million behind with most of it in an IRA or 401(k) and have beneficiaries attached to it. The remaining part will go through the estate plan. In this case, you may be disinheriting a child if:

  • In one area, you split the funds 50/50
  • Another area you split the funds 80/20

When going through a beneficiary review, it’s important to look at the dollar amounts that are given to each child. You may decide to leave $500,000 to one child and $1 million to another child.

In this scenario, one child would need to receive the house and an additional $250,000 and the other $750,000 to split the inheritance evenly. Of course, you can divide your estate up however you see fit, even if that means one child receives far less than the other.

4. Consider Beneficiary Needs

Beneficiaries may have different needs. If one beneficiary is a high-income earner and the other is not, the high-income earner may not need as much money. You may even want to allow the high-income earner to disclaim the inheritance to give to their kids without the high tax burden.

If you have a special needs child, you also need to consider how the inheritance may impact their benefits. In this case, you may want to consider a trust account so that the child still receives their benefits and the help they need.

Another common scenario is that:

  • Your child is not good with money
  • The child may spend all of their money at once

In this case, a trust and a discussion with an attorney can empower you to leave money behind and dictate how it is used with greater control.

5. Be Specific 

For example, your intent is to leave 25% of the money to your grandchildren. It’s better to name the grandkids as primary beneficiaries. The reason for this is that people may forget how you want the money divided, and being very specific in your documentation can help clear any potential confusion.

6. Consult with an Attorney

An attorney is a second set of eyes who will look through all of your beneficiaries and estate plans with you. We know quite a few attorneys who are highly skilled and still hire others to review their documents with them in case they overlook something.

If you need a trust, the attorney can also assist with that.

Legally drafted documents will hold up far better in court than you writing a will on a piece of paper.

7. Consider Contingencies

In our story of the daughter and stepmother above, a contingent would have been immensely helpful. The reason why adding a contingent is so important is that if, for some reason, you get sick and do not check your beneficiaries, you already have a contingency in place.

The father could have listed the mom as the primary and the daughter as a contingent, which would have helped those he left behind avoid arguments and disagreements along the way.

What if the father set the contingent so long ago that both the primary and contingent are no longer living at the time of his death?

He could have left the funds to his grandkids if the institution allowed him to mention “per stirpes,” which means if the primary is not alive, the funds will go down the line to the person’s descendants equally.

Per stirpes is a powerful designation because you don’t even need to know the names of the person(s) to whom you’re leaving the funds. 

Annual beneficiary reviews and putting contingencies in place are powerful tools that we firmly believe are worth using. You can help your family avoid grief and any potential arguments if you spend the time going through your accounts and putting all these measures in place.

Are you curious about retirement and want to gain more insight into the process? Click here to browse through books we’ve authored on the topic.

April 10, 2023 Weekly Update

We do love it when someone refers a family member or friend to us.  Sometimes the question is, “How can we introduce them to you?”   Well, there are multiple ways but a very easy way is to simply forward them a link to this webpage.

Here are this week’s items:

Portfolio Update:  Murs and I have recorded our portfolio update for April 10, 2023

This Week’s Podcast -Why Review Beneficiary Designations Annually?

Listen in to learn the importance of naming contingent beneficiaries after your primary beneficiaries to ensure everything is clear. You will also learn why you need to consider the tax implications of each account, the needs of your beneficiaries, and its impact on your overall estate plan.

 

This Week’s Blog – Why Review Beneficiary Designations Annually?

Retirement planning is a long process. When you first start trying to secure your retirement, your life may be entirely different than it is today. One topic that we’re passionate about is the need to review beneficiary designations annually.

The Stretch IRA is Gone: What Next for Your Inheritance?

The stretch IRA is dead, so what options do you have when it comes to inheritance planning?

At the start of 2020, new rules were introduced on how individual retirement account (IRA) holders can use the “stretch” IRA to manage their inheritance. With changes to the way beneficiaries access inheritance assets, you may have questions about what the rules mean for you and your loved ones.

In this post, we look at what happened to the stretch IRA and how it could affect your inheritance planning. We also cover some of the alternatives to stretch IRAs, including life insurance and Roth conversions.

What happened to the stretch IRA?

On January 1, 2020, the Secure Act was passed and with it came to the end of the stretch IRA. For years, this estate planning strategy was a tax-advantageous way to leave an IRA to a non-spouse beneficiary, but now it’s no longer an option.

So, which new rules were introduced under the Secure Act 2020? And what effect have they had on how IRAs work?

The biggest change concerns how a beneficiary can access an IRA after they’ve inherited it. Previously, a stretch IRA allowed non-spouse beneficiaries unlimited time to withdraw funds from their inheritance. Now, the money must be out of the IRA within 10 years after the date of death, so beneficiaries can no longer access them over their lifetime.

Say, for example, you want to leave $40,000 to your grandchild, who is 30 years old. The Secure Act now means they must withdraw all of the assets within 10 years, either as a lump sum or as annual distribution payments. If they don’t, they’ll have to pay tax all at once, which could significantly reduce their inheritance pot.

Thankfully, the introduction of the Secure Act isn’t all bad news for those with an IRA. There are two other rule changes which many will see as a benefit:

  • The age at which you must withdraw required minimum distributions (RMDs) from your IRA has risen from 70 to 72. This means you’ll have two more years to pay into your retirement account before you need to start drawing money from it.
  • The Secure Act has removed the upper age limit of paying into an IRA. Now, so long as you’re still earning income, you can continue paying into your retirement account indefinitely.

What to consider when withdrawing from an IRA inheritance fund

Now that beneficiaries have just 10 years to withdraw assets from an IRA, they must think about how and when to access their inheritance. Remember, a beneficiary can withdraw funds either as a lump sum or as regular distributions, affecting how much they pay in tax.

If a beneficiary is 60-65 and within 10 years of retirement, it could be worth waiting until they retire before withdrawing money from the IRA. That’s because retirement means a smaller income, so they’ll be in a lower tax bracket and pay less tax on the total inheritance amount.

For younger beneficiaries, withdrawing from an IRA over the 10-year period may be more advantageous – especially if they expect their income to increase as they get older.

Through these examples, you can see why it’s important for beneficiaries to think about the best time to withdraw funds from an IRA. We’d always recommend discussing these options with your beneficiaries so that they can make the most of their inheritance after you’ve gone.

How to manage your inheritance now that the stretch IRA is gone

Now that the stretch IRA is a thing of the past, what other options can help you make the most of your inheritance?

With advanced IRA planning, you can make sure your beneficiaries don’t face a heavy tax burden on their inheritance. There are a few different options that provide good alternatives to the stretch IRA, including Roth conversions and life insurance.

Roth conversions

A Roth conversion is the process of switching your pre-tax IRA assets into tax-free ‘Roth’ assets. This means that you pay the tax on your beneficiary’s inheritance so that all the money they receive is tax-free.

The beauty of Roth assets is that, while the 10-year Secure Act rule still applies, there’s no tax to worry about for both lump sum and annual withdrawals. What’s more, as Roth assets earn interest, it’s well worth letting the inheritance grow over the 10-year period.

A Roth conversion does mean you’ll have to settle the tax bill yourself, passing this benefit to your beneficiary. If that’s important to you, it could be a great option.

Life insurance

The second option we’d recommend as an alternative to the stretch IRA is life insurance. Although slightly more complicated than a Roth conversion, taking out life insurance guarantees tax-free inheritance for your beneficiaries after you’ve gone.

A key thing to note about the life insurance option is that you have to go through underwriting, meaning you first have to qualify. Some people may be concerned that their age will bar them from taking out life insurance, but you may be surprised at the rates and options available.

Life insurance is a great way to ensure your non-spousal beneficiaries can enjoy their inheritance without worrying about tax. What’s more, there’s no 10-year rule on when an inheritor has to withdraw the funds from a life insurance plan, making it a beneficial long-term inheritance option.

So, if you have money set aside as inheritance, life insurance could be the best way to guarantee a tax-free benefit for your loved ones.

Do you need help with your inheritance planning?

We understand that planning your inheritance can be complicated, especially given the recent rule changes introduced by the Secure Act. So, if you need help understanding the different options available, our experts can provide impartial advice on the best way to pass your retirement assets on to your loved ones.

Whatever you’re planning for your inheritance and however big the sum you’ve set aside for your beneficiaries, we can help make the process simpler to manage. Book a complimentary 15-minute call with a member of our team to discuss your retirement goals today.