Someone is going to get your money when you die. Do you know who that will be? What a shame if the money you worked so hard to accumulate over a lifetime were to go to the tax collector, your ex-spouse or a relative you haven't spoken to in years.
That's why January is a good time to check the beneficiaries of retirement accounts and life insurance policies, because they receive the proceeds directly at your death, regardless of what your estate plan directs.
Keep these things in mind about naming beneficiaries to retirement plans and insurance policies:
The owner of an account or policy can change the beneficiary at any time simply by contacting the custodian or plan administrator or life insurer. You should also name a “contingent” beneficiary to stand second in line in case your named beneficiary has died. Keep a list of the beneficiaries you have named for various accounts.
Tax implications for beneficiaries vary. Life insurance proceeds are received by the beneficiary free of taxes; he or she receives the money directly after submitting required proof of death.
The money received by a beneficiary of an IRA is subject to a number of options, including various types of rollovers, depending on whether the beneficiary is the spouse or some other person. These choices can impact the taxes to be paid as money is withdrawn, or is required to be withdrawn, from the retirement account.
The total value of life insurance and retirement policies are included in the asset value of the estate of the person who died while owning the account or policy. The value of those accounts may be substantial enough for the decedent's estate to be subject to estate taxes at the federal or state level.
The beneficiary does not have to be a relative. It could be a friend or a charity. But if you do name a person as the beneficiary of a retirement plan, there are some important tax advantages if the beneficiary understands the rules. So you should leave instructions for the beneficiary not to make an immediate withdrawal from a retirement plan.
Depending on the age of the person who died, and whether the beneficiary is a spouse, there are a variety of decisions to be made about rolling the account into another IRA, which can keep the money growing tax-deferred (or tax-free, in case of a Roth). Each decision will have various tax and withdrawal implications for the beneficiary. To make the right choice, the beneficiary will need professional advice. Major mutual fund companies such as Fidelity and Vanguard have experts to help you make the best decision for your situation.
Do not name a minor as a beneficiary of a life insurance policy or a retirement account. That will likely result in a court-ordered trustee being appointed. That trustee would be empowered to make distribution decisions, which might not be of your choosing (for example refusing to pay tuition to an expensive college).
If you want your children to be beneficiaries of the money, you should consult an estate planning attorney to set up a trust as beneficiary, naming a trustee of your choice, and adding your payout instructions.
It's up to you whether to tell your beneficiary that he or she is next in line to receive your money at your death. But if you're naming an institution or charity as beneficiary, you should make sure you get the proper forms and instructions to correctly name the beneficiary.
No one likes to think about death and beneficiaries. The sooner you make sure you have all your forms updated to reflect your intentions, the sooner you can stop thinking about it. And that's The Savage Truth.
Terry Savage is a registered investment adviser and the author of four best-selling books, including “The Savage Truth on Money.” She responds to questions on her blog at TerrySavage.com.