You have a Last Will and Testament, so all your assets will pass according to this document, right? Not necessarily.
Some types of accounts bypass your will and move to the beneficiaries listed on a form you completed when you opened the account. That’s why you should identify these accounts, and how to properly name your heirs. These simple steps can save your family from confusion and infighting once you have passed.
Defining Probate and Non-Probate Assets
Probate is the legal process of settling your estate and distributing assets to your heirs. Many types of assets move through the courts during this process, like vehicles, real estate, and personal property that are held in your name only. These assets are aptly named “probate assets.”
Some types of financial accounts are “non-probate assets,” meaning that they aren’t distributed based on the instructions in your will. Instead, they pass to the person, persons, or entities named as your beneficiaries. A few of the most common non-probate assets are bank accounts, Individual Retirement Accounts [IRA], brokerage accounts, 401(k)s, and certain types of investment accounts.
You are asked to name beneficiaries when you open one of these accounts, and you have the option to update your heirs as your family or wishes change. As you select or update your beneficiaries, be sure to understand the language used to describe them, as it will impact how your assets are divided.
Primary and Secondary Beneficiaries
Once you understand the importance of naming beneficiaries, you must decide how to split your assets among your loved ones. You’ll do this by identifying your beneficiaries and categorizing them as primary or secondary.
Primary beneficiaries are the people who get “first dibs” on your account. These are usually your spouse or children, but the designation is not limited to family. If they outlive you, then they receive the assets, and your secondary beneficiaries are unneeded.
Secondary beneficiaries are the “what if” inheritors. A good example of these are the direct heirs of your primary beneficiaries. These people receive the assets if your primary beneficiaries pass away before they can inherit.
To illustrate the relationship between primary and secondary beneficiaries, we’ll use a simple example of an account owner named John who is married to Jane. They have two children, Jack and Jill, and four grandchildren.
John wants his IRA to pass to his wife if she is still living when he passes away. If she does not outlive him, he wants his assets to pass equally to his children. Therefore, John names his wife, Jane, as his primary beneficiary, and names his children, Jack and Jill, as his secondary beneficiaries. The following graphic shows the differences between primary and secondary beneficiaries in this example.
Per Stirpes and Per Capita Designations
When you name multiple beneficiaries, you must decide how the money will be split if one of those beneficiaries passes away before you do. This is where the Latin terms per stirpes and per capita come into play.
Per stirpes translates to “by the branch” and it is a designation that allows your assets to move to the children of your named beneficiaries if the named person predeceases you. Per capita translates to “by the head” and it instructs that your assets should be divided among the living beneficiaries only.
In the previous example, John named his children as secondary beneficiaries. If his wife and his son, Jack, pass away before he does, then the designation he used would determine how the money is split.
If John used a per stirpes designation, 50% of his IRA would pass to his living daughter, Jill, and 50% would pass to his son’s children. This keeps the distribution equal for each “branch” of the family. On the other hand, if John used the per capita designation, 100% of his IRA would pass to his living daughter, Jill, since she is the only living beneficiary. Jack’s children would receive nothing. The following graphic shows how John’s assets would pass using the per stirpes and per capita designations.
Special Estate Planning Considerations for Joint Accounts
Beneficiary designations are straightforward when there is only one owner of the original account, like in the examples above. However, there are different rules with a joint account.
There are several types of joint accounts, but three of the most common are Joint Tenants with Rights of Survivorship [JTWOS], Tenants by Entirety, and Tenants in Common. For JTWOS and Tenants by Entirety accounts, assets pass to the surviving owner(s) when the first dies. On the other hand, Tenants in Common accounts allow each owner to name their own beneficiaries.
If you have a joint account or plan to open one, discuss the ownership structure with an experienced financial advisor. They can help you determine if the account type meets your estate planning needs and recommend adjustments to ensure that your assets pass according to your wishes.
Common Pitfalls When Naming Beneficiaries
Even with a clear understanding of the legal terms used to define your beneficiaries, there are common mistakes you need to avoid. For instance, be careful when naming minors as beneficiaries, don’t forget to update beneficiaries as your situation changes, and keep your family informed of your accounts.
Leaving Assets to Minors Without a Custodian Listed
The owner of an investment account must be of legal age to make financial decisions or have a custodian to manage the account on their behalf. If you plan to leave assets to a minor, you’ll need to list a custodian on beneficiary designation forms or risk the courts making this determination on your behalf.
Before you list a minor as a beneficiary, consult an experienced financial advisor and estate attorney to determine the correct language to use on your beneficiary designation forms. These professionals can also provide additional information about other difficulties that may arise after inheritance and offer guidance to minimize the strain on your chosen custodian.
Forgetting to Update Beneficiaries
Many people are unaware that beneficiary designations supersede their will, and they forget to update designations when they adjust their estate plan. Additionally, some people forget to update the beneficiaries on older accounts – leading to outdated designations that are still legally enforced.
For example, people often forget to update beneficiaries on employer-sponsored plans from previous jobs after divorce, leading to an ex-spouse inheriting these assets. Another common issue arises when a person opens an account and names their child as a beneficiary, then has another child and forgets to update their designations. In this case, the first child inherits the entire account, no matter what the will says.
To avoid these situations, keep track of all accounts and the beneficiaries listed. You may also find it helpful to consolidate older 401(k)s or similar plans into one IRA to simplify management and beneficiary changes.
Failing to Keep Beneficiaries Informed
In many cases, beneficiaries must proactively notify the company holding an investment or retirement account of your passing to initiate a swift transfer of assets. They can only do this if they are aware of the account, so make sure that you keep records of your various accounts and provide your beneficiaries with access to these records.
Now that you understand the basics of beneficiary designations, set aside time to review your accounts with an experienced financial advisor. Together, you can ensure your designations are complete and accurate, giving you peace of mind that your legacy is protected.
Review Your Beneficiary Designations and Estate Plan with Meld
At Meld Financial, our team of tax, legal, and investment professionals can help you create an estate plan that matches your wishes. We do this by helping you designate your beneficiaries and determine an appropriate split that minimizes taxes and helps to avoid the probate process.
Estate planning is just one part of our comprehensive financial planning solution, Financial Fingerprint®. This nimble plan accounts for the most common barriers to your financial success and brings together the most important aspects of your financial life into one easy-to-understand plan.
To discuss your personal financial situation or get started with Financial Fingerprint®, contact a member of our team today.
