Thinking about what happens to your money after you're gone isn't most people's idea of a good time. Maybe that's why only 1 in 3 Americans have an estate plan, according to Caring.com's 2023 Wills and Estate Planning Study. A big part of estate planning: designating beneficiaries.
What is a beneficiary?
A beneficiary is a person or entity (such as a charitable organization or trust) that's legally designated to receive proceeds or benefits owned by someone else. Beneficiaries receive those proceeds or benefits when the person who originally owned them passes away. Beneficiaries can be named on bank and brokerage accounts, insurance policies, and retirement accounts, such as 401(k)s and IRAs.
Primary vs. contingent beneficiary
When you choose a beneficiary or beneficiaries, you're usually asked to classify them as primary or contingent beneficiaries. A primary beneficiary is the first person or entity you want to inherit the account or insurance funds after you pass away. A contingent beneficiary is a backup in case the primary beneficiary is deceased, unavailable, or unwilling to accept what they've inherited.
In other words, if a primary beneficiary accepts assets when you pass away, nothing goes to the contingent beneficiary. If the primary beneficiary is no longer alive when you die, cannot be reached, or disclaims the inheritance, the assets pass to the contingent beneficiary instead. Naming a contingent beneficiary could help prevent inheritance delays or problems if your primary beneficiary passes away before or at the same time as you.
Why should you name a beneficiary?
If you don't name a beneficiary for your insurance and financial accounts, the money wouldn't just disappear if you die. If you have a will, the assets would go into “probate,” a months- or even years-long process during which a court validates a will and checks that taxes, debts, and fees are paid. After taxes, fees, and expenses are paid, the heirs named in your will would receive their proportional interest of your estate based on the terms of your will. If you die without a will, assets would still go into probate and be disbursed according to state laws, known as intestacy laws. That's why naming a beneficiary could have the following advantages:
Having a beneficiary avoids confusion. Beneficiary instructions clearly lay out what will happen to your retirement accounts and life insurance proceeds once you're gone. Without these instructions, family members could disagree over who should receive what, especially if there's no will or your will isn't clear. It's worth noting that named beneficiaries supersede instructions in your will. So if you name someone as a beneficiary of an account, they will inherit it, even if your will names someone else.
It speeds up distributing assets. If you've chosen beneficiaries, the associated accounts don't go to probate. If you haven't, your money could get tied up in the court just when your heirs might need it to cover your final expenses or to support themselves. With properly designated beneficiaries, assets can pass to intended heirs in an orderly manner outside of the probate process. If an estate owes taxes, expenses, or liabilities, and the only available assets are held in accounts with beneficiary designations, those accounts may be subject to the debts of the estate before being distributed to beneficiaries.
It could save money. Probate court isn't free. The larger the estate, the more it could cost, with fees potentially costing up to roughly 3% to 8% of the estate's total value. By transferring your insurance payments and retirement accounts through beneficiary instructions instead of probate, you could lower costs, leaving more behind to your heirs.
Types of accounts that might need beneficiaries
There are a few common accounts that allow you to name beneficiaries. If you list a primary beneficiary, it makes sense to list a contingent beneficiary, too. Accounts that let you designate beneficiaries include the following:
- Annuities—aka investments issued by insurance companies—pay out income during your lifetime and could also include a death benefit. In that case, beneficiaries receive whatever money hasn't been distributed or a preset minimum.
- Life insurance. The whole point of having a policy is to help loved ones after you're gone.
- Nonretirement bank and brokerage accounts. These accounts could use a Transfer on Death (TOD) registration, which passes the account along in much the same way as beneficiary instructions do.
- Retirement accounts such as 401(k)s, 403(b)s, and Individual Retirement Accounts (IRAs)
Can you have more than one beneficiary?
Yes, you could name multiple beneficiaries—multiple primary beneficiaries and multiple contingent beneficiaries. When you name more than one primary beneficiary or contingent beneficiary, you can note what percentage of your account's value goes to whom. For example, if you have 3 children, you could set up the beneficiary instructions so that each child receives a third of your retirement accounts and life insurance payouts. You could even choose an organization as a primary or contingent beneficiary, in addition to or instead of people. If a named beneficiary dies before you do, their share is distributed among the remaining beneficiaries at their same tier, unless you provide what's called a per stripes designation that distributes their share to their children.
Who should you name as a beneficiary?
That's up to you, with a few caveats. Many people choose the following as beneficiaries:
- A spouse or long-term partner
- Adult children
- Other family members or close friends
- A trust, which is a legal entity that would manage an inheritance on behalf of your heirs and pay out the money over time. It wouldn't give them everything all at once, which could be a good option if you want minor children to receive assets.
- An organization you'd like to support
There are some people who can't be beneficiaries for certain accounts. For example, minor children can't inherit retirement accounts or a life insurance payout. If you name children younger than 18 as beneficiaries (or younger than 19 or 21 in a few states), the court will choose a custodian to manage the money on their behalf until they are legally eligible to inherit the money. You could avoid that by setting up a trust to inherit everything for your children until they turn 18, 19, or 21, depending on your state's laws.
For some qualified plans, spouses are the primary beneficiary unless a spousal waiver has been obtained and/or the plan satisfies the applicable safe harbor provision. In community property states, spousal consent may be required if you name a beneficiary other than your spouse on certain accounts, like IRAs.
Also think carefully—and consider consulting an attorney who understands the complexities of special needs laws in your state—before leaving property to someone with special needs. An inheritance could disqualify them from receiving government benefits. Leaving the property instead to a special needs trust could be a better option to preserve benefits eligibility.
Remember also that there may be state tax implications and consequences of a beneficiary designation. It could be smart to meet with a tax advisor or financial professional before designating a beneficiary.
How to add or change a beneficiary
Adding or changing a beneficiary is usually quick and straightforward. You might be able to update your beneficiaries right from the website of the bank, insurance, or investment company that holds your account. Otherwise, you might need to request a beneficiary change form. In either case, you'd need to add the new beneficiary's name, date of birth, and Social Security number, as well as their relationship with you. You'd also need to decide how to divide your assets if you're designating more than one person or entity in a single beneficiary tier. If you change your beneficiaries, consider letting the affected people know so they aren't caught off-guard in the future.
Options beneficiaries have for inherited 401(k)s, IRAs, and other retirement accounts
People contribute money to certain retirement accounts, such as a traditional IRA or 401(k), on a pre-tax basis. That means if you leave money in these accounts to heirs, they would have to pay taxes on any withdrawals. (Here's what else happens to a 401(k) when you die.) Depending on their relationship to you, they have the following options:
- Lump sum withdrawal. If any heir would like all the money they're entitled to right away, they may make a single lump sum withdrawal. This could result in significant income tax liabilities and should be done in consultation with a tax professional.
- Withdrawals over a 10-year period. Unless certain exceptions apply, your heirs could spread out withdrawals over 10 years. This gives the retirement funds more time to potentially grow tax-deferred—and gives heirs the option to take out money when they need it. But unless the heir is your spouse, they would need to take distributions within 10 years of your death.
- Lifetime withdrawals (for spouses only). Spouses have more flexibility than other heirs. They could transfer money from your retirement accounts into their own, which allows them to spread the withdrawals over the rest of their lifetime. Or a spouse could take over your 401(k) or IRA and manage it as though it was their own. See more about inherited 401(k) rules and read more about Secure act changes to inheriting IRAs.
The choices could be overwhelming and confusing, so you might want to speak with an estate planning attorney to discuss them and your inheritance goals. You could also consider letting your heirs know what you've set up so they could consider chatting with a financial pro.