How Do Beneficiary Designations Work?

Beneficiary designations guarantee that certain assets are transferred efficiently at a person’s passing. Assets with designated beneficiaries transfer automatically to the named beneficiary, no matter what is in the original asset owner’s Will or Trust document instructions.  In essence, beneficiary designations supersede the provisions in a Will or Trust.

Inside Indiana Business’s recent article, “Who are your beneficiaries?” explains that, because the new owner is determined without the guidance of a Will or Trust document, assets with designated beneficiaries are excluded from the decedent’s probate estate. The fewer assets subject to probate, the less cost and time associated with settling the estate.  However, the assets transferred by beneficiary designation may still be subject to inheritance tax except for the death benefit of life insurance in Pennsylvania which is exempt from inheritance tax.

Many different types of assets transfer via beneficiary designation at the death of the original owner. These include retirement accounts (IRAs, Roth IRAs, 401(k)s, 403(b)s, 457(b)s, pensions, etc.), life insurance death benefits and the residual value of annuities. Bank and brokerage accounts can also be made payable on death (POD) or transferable on death (TOD) to a named beneficiary, if desired. POD and TOD designations bypass probate–like beneficiary designations.

The asset owner can name both primary and contingent beneficiaries. The primary beneficiary is the first in line to inherit the asset. However, if the primary beneficiary predeceases the owner, the contingent beneficiary becomes the new owner. If there is no contingent beneficiary listed, most assets default to the owner’s estate for distribution. There is no restriction on the number of beneficiaries who can inherit an asset.

Charities can also be beneficiaries of assets. Because a charity does not pay income tax, leaving a taxable retirement account or annuity to a charity will let 100% of the value go toward the charity’s mission. When an individual inherits, income tax may be due when the funds are distributed.

A trust can also be named beneficiary of an asset. This strategy is often employed when minors or those with disabilities are beneficiaries. Designating a trust as a beneficiary can be complex, so do so with the advice of an experienced estate planning attorney, such as Rose Kennedy, Esquire, or Sean D. Curran, Esquire, at Curran Estate & Elder Law in Reading, Berks County, Pennsylvania.

Simply naming the estate as a beneficiary of retirement accounts is typically not a good strategy because this can result in unfavorable income tax outcomes for the beneficiaries of those retirement accounts.

Take time to review your current beneficiary designations to be sure they reflect your current wishes. Review these designations at least every five years or when life circumstances change (marriage, birth, divorce, death).

Whenever you name or change a beneficiary, verify that the account custodian or insurance company correctly recorded the information and be sure to keep copies of your beneficiary change forms because errors are problematic, if not impossible, to correct after your death.

Reference: Inside Indiana Business (June 5, 2023) “Who are your beneficiaries?”