What is a beneficiary?
A beneficiary is a person (or entity) chosen to benefit from property that belongs to someone else. Beneficiaries often receive these benefits as part of an inheritance.
A beneficiary can be designated in the documents relating to a life insurance policy, a retirement account, a brokerage account, a bank account, and other financial products.
It’s important to designate beneficiaries for your financial assets so they can be distributed according to your wishes when you pass away.
How Beneficiaries Work
Any person or organization can be named a beneficiary to receive your property after you pass away. The individual who owns the property or the benefactor can put various stipulations on the disbursement of property. These might include the requirement that a beneficiary attain a certain age or be married before taking control of the inherited property.
Failure to name beneficiaries on your financial accounts can result in the financial institution that holds the assets having to make decisions about the distribution of the assets.
Failure to name beneficiaries in a will can potentially tie up one’s property in probate for years. It can leave the decision about how to distribute your assets up to the state in which you live.
In either case, the people you want to provide financial support to after your death may not receive it. Or they may have to wait a long time for it.
Beneficiaries designated on the paperwork for financial accounts override any beneficiary listed in a will.
Why Beneficiaries Are Important
It’s important to designate beneficiaries for your financial property so that you can feel confident that those you’ve decided your money should go to can be assured of receiving it.
- By naming beneficiaries, you control what happens to your money and clarify the matter for all involved.
- Having beneficiaries simplifies settling your estate and can reduce the potential for stressful situations for those you leave behind.
- Changes to a will do not affect the beneficiaries designated for financial accounts, such as an insurance policy or retirement account. These direct designations take precedence.
- The names of beneficiaries in financial account documents remain private. A will becomes a public record and can expose heirs to public scrutiny.
Types of Beneficiaries
Primary
The primary beneficiary is the first beneficiary choice a financial account owner makes. While other beneficiaries may also be listed in account or estate documents, this person or organization will receive all the assets in an account.
Contingent
A contingent beneficiary is a secondary beneficiary. They receive the account benefits only if the primary beneficiary is no longer living or cannot be located. You can name multiple contingent beneficiaries and how the assets would be divided between them.
How to Choose a Beneficiary
Beneficiaries should be designated for all your important assets, including property, insurance policies, retirement accounts, brokerage accounts, and more.
When selecting your beneficiaries:
Assess your relationships with family members and those needing your financial help. You may want to consider family pets who may need your protection.
Review those outside the family you’d like to care for or reward for loyal service through the years. Look at organizations you’ve supported over time and determine whether they can use your financial support.
Designation Process
When opening your financial accounts, companies ask that you provide beneficiary information. If you didn’t provide it, you can request the paperwork to designate one or more beneficiaries. Please fill it out, sign and date it, and return it to the company. This can usually be done online or in person. Maintain a copy for your files.
Examples of Beneficiaries
Individual Retirement Account
An individual retirement account (IRA) allows the holder to designate a beneficiary or beneficiary. The options for distribution of the assets are different depending on whether the beneficiary is an eligible designated beneficiary or a designated beneficiary.
Each beneficiary type may take a lump sum distribution of the proceeds if desired. If not, the choices are as follows.
Eligible designated beneficiary
An eligible designated beneficiary is a spouse, the minor child of the account owner, someone less than ten years younger than the account owner (e.g., a family member or friend), or someone who is chronically ill or disabled.
- A spouse (but no other eligible designated beneficiary) can transfer the assets of the IRA to their own IRA.
- Spouses and all other eligible designated beneficiaries can open an IRA account for the assets they receive. Then, following their life expectancy, they must take distributions over time. The money they withdraw is taxable. Specific distribution rules apply when they must start to take distributions, so be sure to research or discuss this with a financial advisor.
Designated beneficiary
A designated beneficiary is listed in the account records as a beneficiary but doesn’t fit into the category of eligible designated beneficiary.
- Open an Inherited IRA account for the assets. Access any amount of the money anytime, but it must be withdrawn within ten years. If it isn’t, a 50% penalty could apply. The money withdrawn is taxable.1
- The stretch option that allowed beneficiaries to take distributions over their lifetimes is not available if the account holder died on or after Jan. 1, 2020.
If the beneficiary is either an estate or a trust (a non-designated beneficiary), the executor or trustee directs the distribution of assets. They may also open an inherited IRA account and distribute according to the rules for non-designated beneficiaries.
Life Insurance Policy
Life insurance proceeds are tax-free to the beneficiary and are not reported as gross income. However, any interest received or accrued is taxable.
Life insurance beneficiaries can be individuals, such as a spouse or adult child, or entities, such as trusts. For example, if you have minor children, you may establish a trust and name it as the beneficiary of your life insurance policy.
If you were to pass away, the policy’s death benefit would be paid to the trust. The trustee would then manage those assets according to the terms of the trust on behalf of its beneficiaries (e.g., your children).
Revocable Beneficiary vs. Irrevocable Beneficiary
Life insurance beneficiaries can be revocable or irrevocable. Revocable beneficiaries can be changed if necessary during the policy owner’s lifetime. This is similar to a revocable living trust, which can also be changed if the trust grantor is still living.
An irrevocable beneficiary is permanent. If multiple beneficiaries are named to a life insurance policy (e.g., a primary beneficiary and several contingent beneficiaries), they would all need to consent to any changes involving an irrevocable beneficiary. Therefore, it’s essential to choose beneficiaries carefully.
What Is a Beneficiary?
A beneficiary is a person or organization named to receive property belonging to another in the event of their death. The benefits received frequently relate to the benefactor’s financial accounts.
What Happens If I Don’t Choose a Beneficiary?
Suppose you don’t designate one or more beneficiaries for your assets. In that case, another person—such as a financial institution or a court in the state where you reside—will decide what happens to your money.
How Difficult Is Designating a Beneficiary?
Once you’ve decided who they should be, it’s not complicated. Designating beneficiaries for your financial accounts involves providing the names, social security numbers, and other specifics on a form when you open your account. If your accounts have been open, request the appropriate form(s) for designating beneficiaries, fill it out carefully and correctly, and return it to your financial institution.
Who Can Change the Beneficiary on a Life Insurance Policy?
In the case of a life insurance policy with one or more revocable beneficiaries, the policy owner can change the beneficiary designations at any time. This may be necessary if a beneficiary passes away or the primary beneficiary is a spouse, and the marriage ends in divorce.
If irrevocable beneficiaries are named to a life insurance policy, then the policy owner would need the beneficiary’s consent and any contingent beneficiaries to make a change. Therefore, it’s essential to think carefully when choosing policy beneficiaries.
If you care about dispensing your financial assets after you’re gone, choosing beneficiaries for your financial accounts should be a priority. By designating beneficiaries, you can ensure your property is in the right hands.
Conclusion
- A beneficiary is an individual who receives a benefit, which is often a monetary distribution.
- Distributions can have tax consequences.
- Beneficiaries who inherit a retirement account may have various funds distribution options.
- Options for distributions from inherited IRAs depend on whether the beneficiary is an eligible designated beneficiary or a designated beneficiary.
- You can change the beneficiaries on financial accounts anytime, though completing and returning the relevant paperwork is required.
