A beneficiary is a person or entity you choose to receive the savings from your retirement account when you pass away. Unlike assets transferred through a will, retirement account beneficiaries typically receive funds directly and quickly, bypassing the lengthy probate process.
Types of Beneficiaries:
- Primary Beneficiaries: These individuals receive your assets first. This is usually someone in your family or your spouse, but you can choose anyone to be a primary beneficiary.
- Contingent Beneficiaries: Also called secondary beneficiaries, these individuals only receive your assets if your primary beneficiaries can’t or won’t accept them.
- Eligible Designated Beneficiary (EDB): An Eligible Designated Beneficiary is a specific type of beneficiary outlined in the SECURE Act of 2019. These beneficiaries may have the option to take distributions over their lifetime instead of within 10 years, offering greater flexibility. This includes:
- the surviving spouse of the account holder
- a child of the account holder who has not reached the age of majority (as defined by the IRS)
- An individual who is disabled
- an individual who is chronically ill, or
- an individual who is not more than 10 years younger than the account holder.
- Designated Beneficiary (DB): A Designated Beneficiary is any living person you’ve named as a beneficiary who doesn’t qualify as an Eligible Designated Beneficiary. They’re still considered individuals for inheritance purposes, but the withdrawal rules may be more limited.
- Not Designated Beneficiary (NDB): These are non-living beneficiaries, like charities, estates, or trusts you may have named. These aren’t individuals, so different rules apply for how the assets are handled.
You can name multiple beneficiaries for a single retirement account, and you can even choose what percentage each person should receive. For example, you can decide that your partner gets 50% of your 401(k) while your two children each get 25%.
How Beneficiary Designations and Wills Work Together
When it comes to your retirement accounts, it’s important to know that your beneficiary designations will always take priority over your will. Your will covers things like your home or personal belongings, but retirement accounts like IRAs or 401(k)s are handled separately.
For example, if your will says your spouse should inherit everything, but you’ve listed your children as beneficiaries on your retirement account, the money in that account will go to your kids, not your spouse. That’s because beneficiary designations override what’s in your will.
To make sure everything goes as planned, it’s a good idea to regularly review and update both your will and your retirement account beneficiaries. Keeping them aligned helps make sure your wishes are followed and deters any unexpected outcomes.
Why Designating Beneficiaries Matters for Your Financial Future
Naming beneficiaries for your retirement accounts isn’t just paperwork - it’s a powerful financial planning tool that gives you:
- Complete Control: You decide exactly who gets your money and how much they receive.
- Speed and Efficiency: While wills can take over a year to go through the probate process, retirement assets with named beneficiaries can be transferred in as little as a few days.
- Tax Advantages: Choosing certain beneficiaries can mean there’s less tax for the beneficiary to pay. For instance, a spouse gets more flexibility and potential tax benefits than a non-spouse, which can give your money more time to grow.
- Priority Over Your Will: Most people don’t realize that beneficiary designations typically take precedence over what’s written in your will. So even if your will says your estate should be split equally between your children, if someone else is listed as the beneficiary on your 401(k), they’ll receive those funds over your children.
- Protection Against Default Distribution Rules: If you don’t designate a beneficiary, your 401(k) assets will be held in probate or distributed according to your plan’s default guidelines, often starting with your spouse, followed by children, and ultimately your estate. Probate rules may also differ by state, which can affect how your retirement account is distributed if no beneficiaries are designated.
- Preservation of Your Financial Legacy: Your retirement savings may make up a big portion of your wealth. Designating beneficiaries can make sure you leave behind money they can use to pay for education, buy a home, or cover healthcare costs.
How To Add and Update Beneficiaries
Adding and updating retirement account beneficiaries is typically easy, though the specific process differs by provider.
Here’s an overview of how to do it:
- Choose Your Beneficiaries: Designate individuals or charities as beneficiaries for your retirement funds. Provide their full legal names, birth dates, Social Security or EIN numbers, and any other information your provider may require.
- Decide Who Gets What: Consider who you wish to receive your retirement savings and in what percentages. For instance, you might allocate 50% to Beneficiary A, 25% to Beneficiary B, and 25% to Beneficiary C.
- Consider ‘Per Stirpes’ Designations: This means if a beneficiary dies before you, their share goes to their children rather than other beneficiaries. For example, if your three children are equal beneficiaries and one dies before you, that child’s portion would go to their children (your grandchildren). This can ensure each branch of your family still receives their inheritance.
- Complete the Forms: Each retirement account or life insurance policy will have its own beneficiary designation form, which you’ll need to fill in. For 401(k) plans, you’ll need to complete a 401(k) beneficiary designation form, which you can get from your employer or plan provider.
- Review Regularly: Regularly review and update your beneficiary designations, as life events like new relationships or the birth of a child can change who you want to receive your assets. Keeping your beneficiary information current helps ensure your wishes are followed.
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Get startedFrequently Asked Questions (FAQs)
Is an Inherited IRA Taxable?
Yes, inherited IRAs are usually taxable. An Inherited IRA is a retirement account that is opened when someone inherits an IRA or employer-sponsored plan after the original owner dies. However, how and when they’re taxed depends on who inherits them:
- Spouses have the most flexibility. They can treat the inherited IRA as their own, roll it into their existing IRA, or keep the account as it was while having access to the funds. Each option offers different tax advantages, depending on their personal situation.
- Non-spouse beneficiaries usually have to withdraw all funds within 10 years of your death. There are exceptions for certain eligible designated beneficiaries, like young children or people with disabilities.
Can a Beneficiary Designation Be Contested?
Yes, beneficiary designations can be contested!
A designation can be contested on the basis that:
- The account owner lacked mental capacity when making the designation
- The designation was made under undue influence or duress
- The designation form wasn’t properly completed or witnessed
- There was fraud involved
It can be a good idea to keep your beneficiary designations up-to-date to prepare for and avoid any disputes.
Does a Will Override a Beneficiary Designation?
No, beneficiary designations typically override what’s written in your will.
For example, if your will states that your assets should go to your current partner, but your ex-partner is still listed as the beneficiary on your IRA, your ex-partner would likely receive the IRA funds regardless of what your will says.
Do Beneficiary Designations Avoid Probate?
Yes. This is one of the biggest benefits of beneficiary designations! Assets that pass directly to named beneficiaries typically avoid the probate process.
That means:
- Faster transfer to your loved ones
- Less administration
- Lower legal costs
- Greater privacy (probate proceedings are public record)
Can a Beneficiary Be a Family Member?
Yes. Family members are the most common beneficiaries named on retirement accounts. You can name your partner, children, siblings, parents, or any other relatives as beneficiaries.
Additionally, you can also name people who aren’t related to you, such as charities, trusts, or your estate.
What Happens if You Don’t Add a Beneficiary to Your Retirement Account?
There are several downsides to failing to designate a beneficiary for your retirement account:
- Your retirement assets may be distributed according to the default rules of your retirement plan (usually to your partner or your estate, if you’re not married).
- If the assets go to your estate, they’ll usually have to go through probate (varied by state), which can be costly and can take months to over a year to process.
- Without a beneficiary, inheriting your retirement savings could be more expensive.
- The people you want to receive your retirement assets might not get them, or might receive different amounts than you’d have preferred.
Who Gets the Money if the Beneficiary Dies?
If your primary beneficiary dies before you do, and you haven’t updated your beneficiary designation, what happens next depends on how you set up your designation:
- If You Named Contingent (Secondary) Beneficiaries: They’ll receive the assets.
- If You Named Multiple Primary Beneficiaries: The deceased beneficiary’s shares will be split according to the percentages you have decided.
- If You Didn’t Name Contingent Beneficiaries and All Primary Beneficiaries Are Deceased: The assets usually default to your estate.
How Do Beneficiaries Receive Their Money?
After your death, the primary beneficiary, usually the surviving spouse, will need to inform your retirement account provider and provide a death certificate. If the primary beneficiary dies or declines to receive the assets, the contingent beneficiary will need to provide a death certificate. Non-spouse beneficiaries are generally required to withdraw all funds within 10 years of your death.
Once the provider has verified the details, they’ll ask the primary beneficiary how they’d like to receive the money:
- Via a lump sum
- Transferred to their retirement account (applies to married partners only)
- Transferred to an inherited IRA
- Paid in installments over time
There are tax and timing implications of each option, so it’s a good idea for the beneficiary to speak with a financial advisor before making a decision.
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Information contained herein has been obtained from sources considered reliable, but its accuracy and completeness are not guaranteed. It is not intended as the primary basis for financial planning or investment decisions and should not be construed as advice meeting the particular investment needs of any investor. This material has been prepared for information purposes only and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. Past performance is no guarantee of future results.
