A closer look at beneficiaries

In mid-July, we wrote about seven estate planning terms to know because the importance of an estate plan can’t be underestimated.  Not having one can lead to delays, increased expenses, and unneeded hassles.  With that in mind, we wanted to go a bit deeper on three common beneficiary designations.

Designating beneficiaries on your investment accounts, retirement accounts, and life insurance policies is an important part of the estate planning process.  When an individual is named as a designated beneficiary, the assets transfer to them outside of estate proceedings, regardless of the terms of your will.  Though it is possible to name your estate as a beneficiary, it’s important to remember these assets will have to go through probate since an estate is not an individual. This probate process means hiring a lawyer and going through the courts to claim your inheritance.  Though naming your estate as a beneficiary can be costly and time-consuming, this option does work for some individuals depending on their estate plan and overall situation.  It is always important to consult your estate planning attorney to decide the best option for you.

What follows is a deeper discussion of three potential beneficiary designations:

Primary vs contingent

When designating beneficiaries on an IRA account or policy, you will be asked to name primary and contingent beneficiaries.  Primary beneficiaries will be the first entitled to receive the benefits according to the percentage you designate to them.  Contingent beneficiaries will be second in line to receive benefits if all primary beneficiaries are deceased at the time of distribution. These can be individuals or entities (trusts, estates, charities) and more than one can be added.

Example 1:  Mary designates her spouse Larry as 100% primary beneficiary on her IRA account and their two children, Laura and Karen, as contingent beneficiaries at 50% each.  If all beneficiaries are alive when Mary passes, all assets in her IRA will pass to Larry directly.

Example 2: Assuming everything is true in the first example, except Larry predeceases Mary, assets will pass to Laura and Karen at 50% each.

If Mary had not designated Laura and Karen as contingent beneficiaries, all the IRA assets would pass to her estate and go through probate.  Contingent beneficiaries are not required, but in most cases, it is advantageous to have them.

Per stirpes vs per capita

Once you have designated your beneficiaries, you can also select to add either a per stirpes or per capita distribution method.  Adding per stirpes or per capita will ensure your named beneficiaries surviving children will receive a benefit if your named beneficiary is deceased at the time of distribution.

Example 1:  Going back to Mary, let’s assume she selects per stirpes on Laura and Karen (her contingent beneficiaries).  Let’s also assume Karen has two children of her own and Laura has three.  If Larry is alive at the time of distribution, he will receive all the assets.  However, if Larry is deceased and Karen is deceased, Laura will receive her 50% she was designated and Karen’s two living children will receive 25% each, which is Karen’s 50% divided equally.

Example 2:  Going back to Mary again, let’s now assume she selected per capita on Laura and Karen.  If all facts are the same as before, the distribution will happen in the same way as it did under per stirpes.  However, if ALL beneficiaries are deceased (Larry, Karen, and Laura), the distribution will be different.  Let’s look:

Per stirpes would distribute 25% to each of Karen’s two children and 16.67% to each of Laura’s three children.  The grandchildren each split the 50% share their mothers were entitled to evenly between them.

Per capita would distribute 20% each to all five grandchildren.  The five split 100% of the assets evenly between all of them.  This ensures all grandchildren would get an equal share if both of their mothers were deceased.

Transfer on death vs payable on death

These terms are very similar and are used to designate beneficiaries on after-tax accounts in the same way as you would designate beneficiaries on an IRA or 401(k) account.  Transfer on death (TOD) is added to individual or jointly registered brokerage accounts whereas payable on death (POD) is the term used by banks when adding beneficiaries on checking or savings accounts.  If a TOD or POD is used to add beneficiaries to an after-tax account, the assets pass directly to the named beneficiaries and outside of probate.

Changing beneficiaries

Beneficiary designations can be updated at any time during a person’s lifetime.  The custodian of the account—Charles Schwab for almost all P&A clients—will require paperwork to make the updates and the changes will become effective when they receive the paperwork.  Whenever a big life event takes place (i.e., marriage, divorce, birth, death), beneficiaries should be reviewed, and necessary changes should be made.

P&A is currently conducting a beneficiary review on all client accounts with designated beneficiaries.  Over the next few months, clients can expect to receive a letter or email asking to review their current beneficiaries on file with Charles Schwab.  If changes need to be made, we will work with you to do the necessary updates.  If clients have accounts outside of P&A, we suggest reviewing those as well.

If you would like to discuss any of the terms described in this article, please reach out to your P&A advisor, or consult with your estate planning attorney.  If you need a referral for an attorney, we are happy to help as well.

Clicking on the links above may result in you leaving the Pittenger & Anderson, Inc. website. The opinions and ideas expressed on these external websites are those of third-party vendors and Pittenger & Anderson, Inc. has not approved or endorsed any of this third-party content. For the full Terms & Conditions of using the Pittenger & Anderson, Inc. website, click on this link.

Pittenger & Anderson, Inc. does not provide tax, legal, or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal, or accounting advice. You should consult your own tax, legal, and accounting advisors before engaging in any transaction. Additionally, the information presented here is not intended to be a recommendation to buy or sell any specific security. To learn more about our firm and investment approach, check out our Form ADV.

To view this article and others like it online, visit the P&A blog at https://pittand.com/blog/.

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Since 1995, Pittenger & Anderson has guided individuals and families going through money-in-motion events. We are a fee-only Registered Investment Advisor and a full-time fiduciary providing investment management, financial planning, and complimentary services to 800+ clients in over 30 U.S. states.

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