Newburg | CPA Tax Brief (12/29/2021)
Although your will or revocable trust governs the distribution of many or most of your assets, certain assets — such as retirement plans, insurance policies, and bank or brokerage accounts — require you to name a beneficiary (or beneficiaries). This can be an advantage, because when you die, the funds can pass directly to your beneficiaries without going through probate. But to avoid unpleasant surprises, it’s critical not only to choose your beneficiaries carefully, but to also name contingent beneficiaries in case a primary beneficiary dies before you.
Outcome depends on asset type
Suppose a beneficiary predeceases you but you don’t get around to updating the beneficiary form before you die. If you haven’t named a contingent beneficiary, then the disposition of the funds depends on the type of asset.
For retirement plans, the plan document might call for the funds to go to your spouse or, if you’re not married, to your estate. Leaving retirement plan assets to your estate can have undesirable consequences. For one thing, they’ll pass according to the terms of your will, which may be contrary to your wishes. Plus, they’ll have to be distributed and taxed under a five-year rule, depriving your beneficiaries of opportunities to defer those taxes for 10 years or more.
For other types of assets, the funds will likely end up in your estate, which can lead to unfortunate results. Suppose, for example, that your will leaves your entire estate, valued at $1 million, to your son. You also have a $1 million life insurance policy naming your daughter as beneficiary. If your daughter predeceases you and you haven’t updated the beneficiary designation or named a contingent beneficiary (your grandchild, for example), then your son will receive everything, effectively disinheriting your daughter’s family.
Have a backup plan
To ensure that your wishes are fulfilled, name at least one contingent beneficiary for each primary beneficiary. Your contingent beneficiaries can be virtually anyone you choose, including distant family members, friends, or even charitable organizations. Contact us if you have questions regarding beneficiary designations. We’d be pleased to help.