Beneficiary Designations

Beneficiary designations are among the most powerful yet frequently misunderstood estate planning tools. These contractual arrangements control how certain assets pass at death, and they override your will. For CFP professionals, understanding beneficiary designations is critical because errors in this area can completely derail even the most carefully crafted estate plan.

Assets Controlled by Beneficiary Designations

The following assets transfer according to beneficiary designation forms, NOT by will or trust:

Critical Point: These assets pass outside of probate directly to the named beneficiary, regardless of what your will says.

The Hierarchy: Why Beneficiary Designations Override Wills

Beneficiary designations are contracts between you and the financial institution. Contract law takes precedence over testamentary documents (wills). This means:

• If your will says "I leave my IRA to my children equally" but your IRA beneficiary form names your ex-spouse, your ex-spouse receives the IRA
• The financial institution is legally obligated to follow the beneficiary designation on file
• Courts consistently uphold beneficiary designations over conflicting will provisions

Real-World Consequence: An outdated beneficiary form naming a former spouse or deceased parent can completely defeat your estate planning intentions.

Primary vs. Contingent Beneficiaries

Primary Beneficiary

The first-in-line recipient who inherits if they survive the account owner:

• Can be one or multiple individuals
• If multiple, specify percentage or "equally" or "per stirpes"
• Receives the entire asset if living at owner's death

Contingent (Secondary) Beneficiary

The backup recipient who inherits only if the primary beneficiary predeceases the owner:

• Critical for complete estate planning
• Provides a safety net if primary dies first
• Can include multiple levels (secondary, tertiary)

Example Structure:

• Primary: Spouse (100%)
• Contingent: Children (equally, per stirpes)
• If no contingent named and spouse dies first: Asset goes to estate (worst outcome)

Why Contingent Beneficiaries Matter

If your primary beneficiary dies before you and you have NOT named a contingent:

1. The asset typically defaults to your estate
2. The asset must go through probate
3. For retirement accounts, this triggers accelerated distribution requirements
4. Tax benefits (stretch provisions) may be lost

Per Stirpes vs. Per Capita Distribution

These Latin terms determine how assets are divided if a beneficiary predeceases the account owner:

Per Stirpes ("By Branch")

Assets are divided among family branches. If a beneficiary dies, their share passes to their descendants.

Example - Per Stirpes: Account owner names three children as beneficiaries, per stirpes:

• Child A: Living - receives 1/3
• Child B: Deceased (but has 2 children) - Child B's 1/3 passes to grandchildren (1/6 each)
• Child C: Living - receives 1/3

Result: 5 people share the account: Child A (1/3), Child C (1/3), and 2 grandchildren from Child B (1/6 each)

Per Capita ("By Head")

Each surviving beneficiary at the same generation level receives an equal share. Deceased beneficiaries' shares are redistributed among survivors.

Example - Per Capita: Same scenario with per capita designation:

• Child A: Living - receives 1/2
• Child B: Deceased - share redistributed to living children
• Child C: Living - receives 1/2

Result: Only 2 people share: Child A (1/2) and Child C (1/2). Child B's children receive nothing.

Comparison Table

CFP Exam Tip: Per stirpes is generally preferred for family planning because it keeps assets within each family branch and includes grandchildren.

Common Beneficiary Designation Mistakes

1. Naming Your Estate as Beneficiary

Problem: This is one of the most costly mistakes in estate planning.

• Retirement accounts become subject to probate
• Loss of stretch IRA benefits for individual beneficiaries
• Potential exposure to estate creditors
• Accelerated distribution timeline (often 5 years)

Solution: Always name individuals or qualifying trusts as beneficiaries.

2. Failing to Name a Beneficiary

Problem: The financial institution's default rules apply, which typically direct assets to your estate.

• Same negative consequences as naming your estate
• May not align with your wishes

Solution: Complete beneficiary forms for ALL accounts; never leave blank.

3. Not Naming Contingent Beneficiaries

Problem: If primary dies first, assets default to estate.

Solution: Always name contingent beneficiaries; consider multiple layers.

4. Outdated Designations

Problem: Life changes but beneficiary forms remain unchanged.

• Ex-spouse may inherit (divorce does NOT automatically revoke in all states)
• Deceased individuals named (causes delays and complications)
• Pre-marriage designations may exclude spouse or children

Solution: Review beneficiaries regularly and after every major life event.

5. Vague Designations

Problem: Using terms like "my children" without specific names.

• May exclude stepchildren (varies by state law)
• May include unintended individuals
• Creates ambiguity and potential disputes

Solution: List full legal names, dates of birth, and Social Security numbers when possible.

6. Inconsistent Designations Across Accounts

Problem: Different beneficiaries on different accounts may not achieve intended distribution.

• One child may receive $500,000 while another receives $50,000
• Complicated by account growth/decline over time

Solution: Review all accounts together; coordinate as a complete plan.

Review Triggers: When to Update Beneficiaries

Review and potentially update beneficiary designations after these life events:

SECURE Act Considerations (2020 and 2024 Updates)

The SECURE Act significantly changed distribution rules for inherited retirement accounts:

Most Non-Spouse Beneficiaries

• Must empty inherited IRA within 10 years of owner's death
• Annual RMDs may be required depending on circumstances
• "Stretch IRA" largely eliminated for non-spouse beneficiaries

Eligible Designated Beneficiaries (Exceptions)

These beneficiaries may still use life expectancy distributions:

1. Surviving spouse
2. Minor children (until age 21)
3. Disabled individuals
4. Chronically ill individuals
5. Beneficiaries not more than 10 years younger than the deceased

Planning Implications

• Consider Roth conversions to reduce tax burden on beneficiaries
• Trust planning requires careful drafting for retirement accounts
• Spousal beneficiaries retain most advantageous treatment