When you draft a will or a legal contract or set up a financial account (such as a bank account, insurance policy or retirement plan), you’re usually required to designate a beneficiary. The beneficiary you name will inherit your assets in the event of your passing.
Understanding the beneficiary process and choosing the right beneficiary is a critical step in planning your estate. Let’s find out why and take a closer look at the process.
What is a beneficiary?
A beneficiary is a person or entity who inherits predetermined assets from an individual after that individual passes away. In this context, an entity can be any legal or organizational structure, such as a charity, business, educational institution, trust or government agency. Beneficiaries can inherit physical property, retirement accounts, trust funds, life insurance assets and more.
Most beneficiaries are people, but they can also be organizations, referred to as “entities.” Entities can also refer to financial accounts if you want to put money into a trust.
Why are beneficiaries important?
By choosing recipients for your assets, you can help secure your beneficiaries’ financial well-being. That’s important because:
- Making beneficiary designations can help distribute your assets according to your wishes. Without clear designations, the process of transferring your assets can be complicated and could cause disputes.
- Designating a beneficiary can help your heirs avoid probate court — which can be an expensive and time-consuming process — and allow for expedited transfer of your assets.
- Choosing a beneficiary provides a simpler way to transfer assets, minimizing the need for extensive paperwork. It also offers greater flexibility for modifying your choices in some estate plans, as you can typically update designations based on your changing life circumstances.
How naming a beneficiary works
Designating a beneficiary ensures your property will be distributed according to your wishes after your passing. This usually means naming beneficiaries in your will or trust, but it can also apply to:
- Life insurance: Choosing a beneficiary ensures your life insurance policy’s death benefit is disbursed according to your wishes. Life insurance beneficiaries can be revocable, meaning subject to change, or irrevocable, meaning they’re a permanent heir. Only the owner of a life insurance policy can change revocable beneficiaries. If they wish to change an irrevocable beneficiary, it has to be done with the consent of that beneficiary.
- Retirement accounts: There are two types of beneficiaries related to retirement accounts:
- Eligible designated beneficiaries: These can be a surviving spouse, minor child of the account holder, friend/family member not more than 10 years younger than the account owner or a disabled/chronically ill person.
- Designated beneficiaries: These are entities or persons who don’t fit into the eligible beneficiary category and have less priority than eligible designated beneficiaries. This means that during the distribution of assets, designated beneficiaries are considered lower in the order of precedence, and their claims or rights may be addressed only after the needs of eligible beneficiaries have been satisfied.
- Living trusts: In this case, the beneficiary is the person or entity you choose to take ownership of the trust’s assets after you die.
- Bank and investment accounts: Most financial institutions allow you to name a beneficiary to ensure a smooth transfer of funds after your passing. This can include bank accounts — such as savings and checking accounts — as well as investment accounts, like brokerage accounts.
If you don’t name any beneficiaries, the assets you leave behind could be mired in probate court proceedings for months or years. It may ultimately fall to the state or relevant financial institutions to decide how to distribute them.
Types of beneficiaries: Primary vs. contingent
Beneficiaries fall into two broad categories: primary beneficiaries and contingent beneficiaries. Their basic function is the same, but they’re subject to different rules.
Primary beneficiaries are your “first choice” for who or what will inherit your financial assets. They hold an advantage over contingent beneficiaries when it comes to inheritance because even if your estate is contested or you make changes to your will, the primary beneficiary will still receive the assets designated to them. Keep in mind that you can distribute assets among multiple primary beneficiaries, as long as you indicate the percentage each should receive.
These are secondary beneficiaries, and they’re named as inheritors only if the primary beneficiary can’t claim the assets. This could occur if the primary beneficiary passes away or if they’re unable or unwilling to receive the assets. You can add multiple contingent beneficiaries to a financial account, as well as specify how your money should be divided amongst them. Unlike designated beneficiaries, contingent beneficiaries only receive inheritance when a specified event occurs that transfers their status from secondary to primary inheritors.
How to choose a beneficiary
Choosing a beneficiary is a personal process — there’s no one-size-fits-all approach. Whether it’s for a life insurance policy, retirement account or other assets, choosing a beneficiary involves carefully evaluating various factors.
Some things you may want to do before choosing a beneficiary include:
- Assess your relationship with loved ones and choose someone you trust to manage the assets you leave behind.
- Plan to name both a primary beneficiary and a contingent beneficiary in case unforeseen circumstances arise and the primary beneficiary is unavailable.
- Factor in the age and financial readiness of any potential beneficiaries, especially in the case of minors. If you’re designating a minor, consider establishing a trust or specifying a guardian to oversee the assets until they reach a certain age.
- Consider consulting with a financial advisor to help ensure your beneficiary designations align with your overall estate planning and financial goals.