Let’s start with what a beneficiary designation is.

You know when you get forms from that HR person at work that have your 401k paperwork? Or maybe a financial advisor gives you forms for life insurance? Or maybe you independently set up a retirement account online and had to fill out some information to get it going?

USUALLY, there is a field or section dealing with Beneficiary Designations, and it’s usually divided into two subsections: Primary Designation and Secondary/Contingent Designation. In these subsections you will be asked to indicate inheritance using percentages.

What is the difference between primary and contingent?

Primary is the person or persons who, upon your death, FIRST inherit this account. Thus, if your intent is that your spouse (and only your spouse) inherit your account, you would list them inheriting 100%.

The contingent(s) (or sometimes called secondary beneficiary) inherits if both you AND your primary beneficiary(ies) are dead. Usually, if you are married, the contingent would be your children.

What is the significance of filling out a beneficiary designation?

When you indicate beneficiaries you make a contract with the institution. You are contracting that at your death this institution is obligated to pay the money to your beneficiaries. This is important. Many people assume that their estate planning will override and trump how retirement and life insurance are inherited. BUT in the hierarchy of law, contract law supersedes estate law.
This means that whoever you have listed as your beneficiaries on these policies will be given the percentage you’ve indicated, even if it differs from your estate planning or will.

4 Common Pitfalls
There are four common pitfalls regarding beneficiary designations that I frequently see.

1. Leaving it all to one child to dole out to the other children: This is a problem because the child named legally inherits all of the funds. This child will have no legal obligation to share the money. However, even if they do share, that “sharing” is now legally considered a gift, rather than inheritance, thus complicating taxes.

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2. Leaving money directly to minors: The problem here is that minor children cannot directly inherit. In these cases, institutions hold the money until there is a court-appointed conservator to control it. The child will not have control of the money until they become an adult. And by adult, we mean, a 21 year old. So the money will be difficult to access while the child is a minor and then all the sudden, they will be in total control upon turning 21.

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3. Not making any beneficiary designation: This will force the money through a probate in order to be distributed. And while this is not such a big deal for life insurance, for retirement accounts it means that the funds have to be paid out in 5 years instead of 10 years, often resulting in greater taxes for the inheritor for retirement funds.

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4. Misunderstanding Primary vs. Secondary Logistics: I had a case a few years ago where the deceased’s primary beneficiary designation was 50% to his wife, and 25% to each of their minor daughters. Now perhaps this was his intent, but the way it logistically played out was that even after his wife went to court to become the conservator of the funds left to her minor daughters, the judge required that the children’s money be held in a fund (only to be used or distributed by court order) until the daughters were adults. Meaning, the surest way for the courts to honor the beneficiary contract was to make it so cumbersome to use this money, that it would likely stay untouched until the daughters were adults.
Because the wife was only able to access her 50% of the money, she didn’t have enough to pay off their mortgage while also meeting their day to day needs. Likely, it would have saved everyone a big headache if the deceased had just left 100% of his life insurance to his wife, and made his daughters contingent/secondary beneficiaries.
You  want to be sure that the way you’ve filled out your beneficiary designation actually matches your intentions, if not…it can have big consequences.

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What is the best way to make a beneficiary designation to get money to minor children?
The best way is to leave the money to a testamentary trust, it gives you the greatest control and flexibility, and ensures that minor children get money when they are ready. All Really Good Wills have a testamentary trust built into them. You can read more about this here.

What does Per Stirpes mean? When is it useful?
Per Stirpes is a distribution method where money is passed on to the descendants of a beneficiary. For example, if you have 4 children and you leave a share to each of them, per stirpes, then the ¼ share that you leave would pass to their children if your child died before you. Without an indication like this, the common distribution method is to take that ¼ share and redistribute it among the other named beneficiaries. So in this example, that would mean the 3 living children each get ⅓. If you are wanting to make sure that a child’s share gets passed to their children, and you are naming that child or person by name in the beneficiary designation, you’ll want to indicate per stirpes next to their name.

What’s the smartest way to list beneficiary designations in a second marriage?
This is tough because family relationships are complicated. And even though this might be a difficult or drama-laden decision, and unfortunately, there is no one-size fits all approach. Every situation is going to need custom consideration.

For example, it may make sense to name your current spouse and your children from your first marriage all as primary beneficiaries depending on how much is in your estate.

It also might make sense to only name your current spouse as primary beneficiary and then balance this payout to your spouse by leaving inheritance to children (from your first marriage) through life insurance or other property.

Since there are retirement account tax benefits available only to your spouse, quite a bit of strategy goes into deciding how best to pass on retirement accounts in a second marriage situation. This will involve looking at all the assets and being very intentional about how to list the beneficiaries.

Conclusion
While the best way to fill out your beneficiary designations on retirement and life insurance accounts varies, the first step is knowing how you currently have them filled out. Once you know that, you can use this article to strategize improvements to your current designations to facilitate a better all around outcome.

Beneficiary designations should always be considered when making and executing an estate plan. Because accounts shift over time, it is important to check in periodically and ensure you know who you’ve named, why you’ve named them, how money will get to them, and how these contracts play out after you die.

If you have questions, please reach out!