Naming Beneficiaries Common Mistakes

Naming beneficiaries on an IRA (Individual Retirement Account) is critical to ensuring that your assets are distributed according to your wishes. Here are ten common errors people make when naming beneficiaries:

  1. Failing to Name a Beneficiary
    • Why it's a problem: If no beneficiary is named, the IRA may go through probate, causing delays and potentially higher taxes for heirs.
  2. Naming a Minor as the Direct Beneficiary
    • Why it's a problem: Minors can only partially inherit IRA assets. A court-appointed guardian might be required, adding complications. Setting up a trust or custodial account can avoid this issue.
  3. Failing to Update Beneficiary Designations
    • Why it's a problem: Life changes like marriage, divorce, or children's birth can make an old beneficiary designation inappropriate. Many need to update after these changes, leading to unintended heirs receiving the assets.
  4. Naming an Estate as the Beneficiary
    • Why it's a problem: Naming an estate as the beneficiary subjects the IRA to probate, and the distribution rules may accelerate withdrawals, potentially causing higher tax burdens for heirs.
  5. Not Naming a Contingent Beneficiary
    • Why it's a problem: If the primary beneficiary dies before you and no contingent beneficiary is named, the IRA may go to your estate or be subjected to default rules, which might not reflect your wishes.
  6. Naming a Trust Incorrectly
    • Why it's a problem: Trusts can be beneficial but must be appropriately structured to qualify as a "see-through trust" for tax purposes. If done incorrectly, the IRA distributions may be accelerated, losing the ability to spread withdrawals over a beneficiary's lifetime.
  7. Overlooking the Spousal Inheritance Rules
    • Why it's a problem: Spouses have unique options, like rolling the IRA into their name. Failure to understand or utilize these options can result in less favourable tax treatment.
  8. Not Considering Tax Implications for Non-Spouse Beneficiaries
    • Why it's a problem: Non-spouse beneficiaries must typically withdraw the entire IRA within ten years under the SECURE Act. Not planning for these withdrawals could result in significant tax bills for beneficiaries.
  9. Naming Multiple Beneficiaries Without Clarifying Proportions
    • Why it's a problem: If you name multiple beneficiaries without specifying how much each will receive, the assets might not be divided as you intend, leading to family disputes or unfair distribution.
  10. Assuming a Will Overrides the Beneficiary Designation
    • Why it's a problem: The IRA beneficiary designation trumps your will. Many people incorrectly believe that their will can change who inherits their IRA, but this is not the case.

Conclusion

Regularly reviewing and updating beneficiary designations based on life events, ensuring clear and appropriate selections, and understanding the tax and legal implications will help avoid these common errors.

The essence of investment management is the management of risks, not the management of returns.
Benjamin Graham