How To Avoid Beneficiary Mistakes In Estate Planning

When it comes to estate planning, many people assume that as long as their estate planning documents are up to date, then everything else will be okay. They might have a last will and testament, financial power of attorney, and perhaps a living will or health care surrogate designation. 

While it’s important to maintain your estate planning documents, that’s not enough. In order to have a comprehensive estate plan, you need to have and maintain beneficiary designations.

Without beneficiary designations in place, your estate plan might encounter unintended consequences. Examples of such pitfalls include:

• Unnecessary costs in transferring substantial assets through the probate process
• Possible legal fights over asset ownership
• Improper distribution of your property.

In this article, we’ll go over beneficiary designations in a little more depth, by covering:

• What beneficiary designations are
• What types of financial accounts beneficiary designations cover
• What types of beneficiary designations you should expect to know about 
• Why your legal documents don’t take the place of beneficiary designations
• Common estate planning mistakes people make with their beneficiary designations and how to avoid them

What is a beneficiary designation?

A beneficiary designation instructs a financial institution where to transfer financial assets when the account owner passes away. Such financial institutions include:

• Banks
• Insurance companies
• Investment custodians

This could be (and is usually) money. However, beneficiary designations also direct the transfer of other assets, such as stocks, bonds, or mutual funds to the designated beneficiary.

Unlike a will, which requires probate, beneficiary designations bypass the probate process.

What types of financial accounts do beneficiary designations cover? 

Most of the time, people associate beneficiary designations with investment accounts. For example, when people open retirement accounts like an IRA (individual retirement account), beneficiary designation forms are often included in the account-opening paperwork.

However, beneficiary designations also cover other financial accounts. When you establish bank accounts, you’re often asked to fill out paperwork for payable on death (POD). POD designations are a form of beneficiary designation.

Life insurance policies are another place where you’ll find beneficiary designation. In fact, a life insurance policy is established primarily for the benefit of someone else, not the policy holder.

What types of beneficiary designations do I need to know about? 

Here are some terms your financial institution might use when talking about beneficiary designations: 

Payable on death (POD)

POD designations are typically used by banks or credit unions.

POD designations serve to transfer assets from banking accounts like a checking account, savings account or money market account. If you’re holding a certificate of deposit (CD) at a banking institution, it will also have a POD designation.

Transfer on Death (TOD)  

TOD designations are commonly used by financial custodians to transfer investments located in investment accounts. TOD designations are often used by workplace retirement plan administrators.

Example accounts include:

• Taxable investment accounts
• IRAs (including SEP IRAs and SIMPLE IRAs)
• Roth IRAs
• Qualified retirement plans (such as a 401k or 403b)

Investments that can be transferred by TOD designation include:

• Stocks
• Mutual funds
• Bonds
• Exchange-traded funds (ETFs)
• Certificates of Deposit (CDs)

Primary beneficiary  

One (or more) legal entity designated to receive a share of assets in the account holder’s account in case of death. If there is only one primary beneficiary, that beneficiary automatically receives 100% of the asset distribution.

If there is more than one primary beneficiary, then the account owner will usually use a percentage to determine what portion of the assets goes to each beneficiary.

For example, John has 2 sons, Tom and Charles. Both are primary beneficiaries of his Roth IRA. John might establish his beneficiary designations as:

• Tom-50%
• Charles-50%

Or John might decide that Tom is entitled to a higher percentage of the investments in his Roth account. In that case, he might establish his designations as:

• Tom-75%
• Charles-25%

The primary requirement is that the percentages add up to 100%. So if John tried to split the Roth IRA equally three ways, he could not.

One person would have to receive 34% of the assets, while the other two received 33%. Sometimes, to make things equitable, an account owner might designate a charity to receive the extra percent.

A beneficiary doesn’t need to be a specific person. A beneficiary can be a revocable trust or a charity.

However, you may want to discuss this in more depth with your financial advisor or an experienced estate attorney. 

Contingent beneficiary  

Contingent beneficiaries are named in the case one or more of the primary beneficiaries predecease the account owner. A common example would be grandchildren who would be named to inherit money if their parent(s) die first. 

If there is no contingent beneficiary named, and the account owner dies without any living primary beneficiaries, the assets will usually go back to the owner’s estate.

Per stirpes & per capita  

When naming contingent beneficiaries who are descendants of the primary beneficiary, you may encounter these terms. These are two different ways in which money passes to contingent beneficiaries.

Per stirpes

Per stirpes, in Latin, means “by branch.” The per stirpes designation means that if the intended primary beneficiary predeceases the original account owner, then that beneficiary’s descendants receive their share of the distribution.

For example, let’s imagine John and his two sons, Tom and Charles. John’s beneficiary designations are marked, “per stirpes.”

Tom and Charles are co-equal primary beneficiaries (they each get 50% of John’s account when he passes).

Let’s imagine that Tom predeceases John, and John eventually dies. Tom’s share of the account would go to his children.

Per capita

Per capita, in Latin, means “by head.” The per capita designation means that if the intended primary beneficiary predeceases the original account owner, then the remaining primary beneficiaries receive their share of the distribution.

Under the above example, a “per capita” designation means that if John dies, Charles would receive Tom’s share of the account (or 100%, since they were the only two primary beneficiaries), and Tom’s children would receive nothing.

We’ve written this article specifically to explore the details about per stirpes and per capita beneficiary designations.  

How do my beneficiary designations impact my estate planning?   

The simples answer is this:  beneficiary designations bypass the probate process.  

Before we discuss the probate process, here’s a disclaimer. This is not intended to be legal advice. It is strictly for educational purposes only.

Detailed estate planning scenarios are governed by state law. So if you need legal help, you’ll probably want to retain the services of an experienced estate planning attorney. And if you need to make significant changes to your estate planning and trust documents, you’ll need to hire an estate planner to do that anyway.

How the probate process works (in layman’s terms)

If you’re unfamiliar with the probate process, here’s a short (and overly simple) explanation:

• You pass away.
• Your will directs where your assets go, and names someone as the personal representative (or executor) of your estate. This usually is a trusted person, like a relative, close friend, or attorney.
• If your personal representative is an attorney, they can do this for you. If not, most likely, they’ll hire an attorney to make sure everything is in order.
• Your representative (or attorney) is legally required to file a notice with your local jurisdiction (or multiple, if you have complicated estate issues).  This ensures that people have enough time to file a claim (if they have a reason to do so). 
• If you have a revocable living trust, your will likely will place everything into the trust. From there, the trust document determines how to distribute the assets.
• If you didn’t do any of this, then your state’s intestacy laws will dictate how to distribute the estate. This is known as intestate succession.
• The more time, money, and energy this process consumes, the less is left over for your heirs.

Sometimes, people disagree on what you intended. And these disagreements come out during the probate process. This happens a lot with:

• Creditors who want the decedent’s estate to pay them
• Family members who disagree on what the deceased person’s intentions were
• People who come from nowhere to lay claim on the deceased person’s property.

How beneficiary designations help

Beneficiary designations avoid all of this. Not only that, but everything happens quickly. Days or weeks, instead of months or years.

And that’s important when grieving relatives have bills to pay.

In my years as a financial planner, I’ve yet to see a situation in which a financial institution has difficulty disbursing money when a beneficiary designation is correctly on file.  

Most arguments are about the money—aside from family sentimental items or major non-financial assets (like real estate), most arguments are about the money.

If you want to minimize the negative feelings amongst your loved ones after you pass away—don’t leave them with outdated beneficiary designations.

Common beneficiary designation mistakes & how to avoid them 

Here are some common pitfalls that I used to see as a financial planner. Almost all of these mistakes are simple. They’re all avoidable if you take the time do what’s required.

Not having beneficiary designations on file.  

Not having any designations on file might be the biggest mistake you can make. And it’s easy to avoid.

When you open an account, your financial institution might offer to help you with this. But they won’t automatically do it for you.

Many people don’t make it past this crucial first step.

How to avoid this mistake:

Take the time to carefully review ALL of your account paperwork. If you have a financial advisor, they should automatically go over this with you in your estate planning or investment meetings.

If your advisor isn’t helping you with this, then you need to find one that does. A financial advisor who can’t help you with the basics now is going to be useless to your grieving loved ones when they need the most help with your accounts.

Not reviewing beneficiary designations regularly.  

What happens when you experience a major life event? Many married couples fall into this trap because marriage is forever. These couples don’t expect a major life change to happen to them.

And then it does.

What if this was an older married couple? And each spouse was on their second marriage? And the deceased spouse neglected to change his beneficiary designations?

Upon the death of the first spouse, what happens to the surviving spouse?

If you pass away without changing your beneficiary designations, it’s likely that your ex will be in for a pleasant surprise.  And your current will be left holding the bag.  

How to avoid this mistake:

Review beneficiary designations at least yearly. If you have a financial advisor, he or she should have this as part of an annual checklist.

Keep a list of major life changes that could happen to you (and your family). You should ALWAYS review designations when:

• A family member passes away
• A new family member is born
• Your marital status changes

Regularly reviewing your designations is the best way to ensure that your financial affairs are in line with your intentions.

Not completing primary and secondary designations.  

Many people will complete primary designations. But not contingent designations.

Sometimes, this might not be a mistake. As a financial planner, I had many clients who simply didn’t have enough people in their lives.

But in many cases, the intent is for the money to go on to heirs like extended family members. But it’s never documented.  

How to avoid this mistake:

Think diligently about where your money should go if your primary beneficiaries predecease you. And consider special circumstances that might come up.

Not accounting for special circumstances.  

What if your contingent beneficiaries (like minor grandchildren) are too young to inherit the money directly?  

What if a beneficiary has a severe disability? In that case, inheriting assets in their own name might disqualify them for financial aid.

How to avoid this mistake:

If you have special circumstances, you definitely need to discuss them with your estate attorney or financial advisor.

For example, an experienced estate attorney might offer suggestions, like establishing a living trust to provide for minor children. Or a special needs trust to provide for long term care for a relative with a severe disability.

Naming the wrong beneficiary.  

Sometimes, mistakes happen, even with the best of intentions.

Remember examples of people who were on the government’s ‘no-fly’ list, who ended up as cases of mistaken identity (here’s an article with some humorous examples)?

Don’t let this happen with something as serious as your money. Here are examples of common mistakes to be on the lo out for:

Take a look for things like name changes (in the case of marriage or divorce), typos, or other mistakes that could be misinterpreted by your financial institution.  

• Name changes (especially for new marriages or divorces)
• Misspellings
• Incorrect Social Security Number
• Incorrect address
• Incorrect birthdates

How to avoid this mistake:

This really falls under attention to detail. Hopefully, your financial advisor will keep on top of this. With financial technology automating a lot of paperwork, these mistakes are becoming less common.

But there’s no substitute for verifying it for yourself.

Not being consistent. 

It’s great that you made the change to your investment accounts and your insurance policies. But did you look at all your accounts and make the necessary changes?

What about your banking account? And do these changes match with your estate planning documents?

How to avoid this mistake:

Create a checklist of all financial accounts. And when you make a change to one account (or to your estate documents), go through the checklist.

You might keep some designations the same. But it should be deliberate and intentional. Not accidental.

Low-hanging fruit, huh? We’re not talking advanced tactics here—just avoiding common mistakes.

And for the vast majority of people reading this article, that’s all we need to discuss. But even if you feel like you have a solid estate plan, it’s a good idea to schedule a regular review with your estate attorney.

Conclusion

Beneficiary designations don’t replace your estate planning. And they don’t replace your estate planning documents. For both, you need to obtain the legal services of an estate attorney.

Nevertheless, beneficiary designations are a crucial part of your estate plan.

And they’re a part of your estate plan that your lawyer probably isn’t going to do on your behalf. Instead, that responsibility falls upon you to make sure your bank representative or financial custodian has the correct designations on file.  

So to make sure your estate plan is intact, talk with your estate attorney or financial advisor about this, and update your beneficiary designations today!