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Bulletproof Your Wealth for the Next Generation

Updated: Feb 15, 2023

Smart retirement planning often begins with setting up and working diligently to contribute to retirement accounts. Whether it’s a 401k or an IRA, many individuals set up a beneficiary when they first open the account, but never stop and review that beneficiary designation down the road. This is similarly true for life insurance policies.

A beneficiary form directs how a deceased participant’s retirement accounts are distributed. Completing beneficiary forms accurately helps avoid problems when a retirement plan participant dies. Failing to complete or update this important document can contribute to the wrong individual(s) inheriting your retirement nest egg.

Put the pieces together to make sure the right heirs receive what you diligently worked hard to create.
Put the pieces together to make sure the right heirs receive what you diligently worked hard to create.

Below are 6 common beneficiary errors I frequently see.

1. Not naming a beneficiary.

An account owner may mistakenly think they can use their will to designate a beneficiary, as they do with other assets of the estate. However, in the case of retirement funds (and life insurance too), not naming a beneficiary leaves the beneficiary determined by the default terms of the 401k or IRA plan document.

The default of most plans require the spouse to receive the benefits. If there is no spouse, then children typically share the benefits in equal shares.

If you’d like more control over who you’d like to see receive your accounts upon your death, then begin by naming the beneficiaries on the account.

2. Not reviewing your beneficiary form regularly or revising after a major life event.

Imagine when a happily married individual with a $2 million 401k account passes away leaving behind two children and a wife from his second marriage. But, his death reveals that the primary 100% beneficiary on his 401k and life insurance was his first wife. Perhaps the man thought his new will would take care of his second wife and children, after all, the will says they get everything. In this scenario, the ex-wife happily accepted the inheritance. Unfortunately, this story is not rare.

From marital status to the death of a parent or the birth/adoption of a child to the emancipation of a minor child, life changes may come in many forms. It is a good practice to review life insurance and retirement beneficiary designations every other year as well as following a major life change. Beneficiaries should also be reviewed when there is a major change in your family’s finances, such as the purchase of a major asset, sale of a business, or a significant inheritance.

It is a good practice to review life insurance and retirement beneficiary designations every other year as well as following a major life change.

3. Believing the will or trust will supersede beneficiaries listed on retirement accounts.

No matter what is written in your will, if your retirement accounts (i.e. 401k, 403b, IRA, and pension plans) designated a different beneficiary that individual will inherit the funds of the account(s). The retirement account listed beneficiary supersedes whatever is written in a will or trust document.

As seen in the example above, this is exactly why the ex-wife inherited the $2 million 401k account. The beneficiary designation that you entered as part of your plan enrollment form takes precedence. The same holds true for life insurance policies.

4. Not naming a contingent beneficiary.

A common mistake on beneficiary forms is designating a primary beneficiary but failing to name a second contingent beneficiary or group of beneficiaries. 

If your primary beneficiary doesn't survive you or decides to decline the benefits, then your contingent beneficiaries receive the benefits. However, if you do not have a contingent beneficiary listed and you fail to update your beneficiary form in the unfortunate circumstance of your primary beneficiary passing before you, then the proceeds may go to your children, parents, siblings, or your estate.

Naming a contingent beneficiary provides you with control and a back-up plan. Once the assets become the property of the primary beneficiary, the contingent beneficiary loses all claim.

5. Naming a minor child as the direct beneficiary.

Minor children cannot inherit as direct beneficiaries. Guardians must be provided to oversee funds until the child reaches 18 or 21 (depending on state) or the court will appoint one on your behalf. This is an expensive process.

To avoid confusion, consider setting up a trust in the children’s name with a trustee chosen by the family. This allows for children to be cared for by a trustee and for the family to specify how old children have to be to receive an inheritance. Your family may want to consider an irrevocable trust for children to inherit due to the added creditor and litigation protections they provide. This is called bullet-proofing your wealth for the next generation.

This is called bullet-proofing your wealth for the next generation.

6. Naming your estate.

A shortcut I often see is when individuals name their estate as the beneficiary of the retirement accounts or life insurance policy. They do this so it is easier to update by having the estate inherited by a list of individuals. One document appears easier to update than multiple. 

However, there is a major side effect to not naming individuals directly on an updated beneficiary form. Time.

When an individual inherits the retirement account or life insurance policy benefits, the funds become immediately payable. If an estate inherits the policy benefits, it may take months (or even years) for the individuals to receive the funds. However, you may wish to name a trust depending on your goals, estate plan, and tax situation.

Final Thought.

Properly designating your beneficiary is part of an overall estate plan. Conflicting naming of heirs opens the door to litigation that wastes money and may create hard feelings in the family. 

Work with your financial advisor and estate planning attorney to set up your retirement plan and life insurance beneficiaries properly.

If you have more than $2 million saved and need a financial plan to reach your goals, the Peak Wealth Planning team can assist.

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About the Author

Peter Newman is a Chartered Financial Advisor (CFA) and president of Peak Wealth Planning. He works with individuals nationwide that have accumulated wealth through company stock, ESOP shares, real estate, or running a business. Peter applies his unique background to help clients achieve their specific goals and enjoy peace of mind.

Peak Wealth Planning provides concierge services to meet your wealth management needs. Services include: financial planning, investment management, esop diversification, retirement income, insurance, and estate planning advice. Peak Wealth Planning is a fee-based financial advisor based in Champaign, Illinois, and Fraser, Colorado.


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