Money Missteps: Beneficiary Blunders, Part 1

Contemplating who we want to add as the beneficiary to our investment accounts or life insurance policies is usually not an activity we undertake with excitement.  The only time a beneficiary designation works is when we die and who wants to think about that?

Nevertheless, beneficiary designations are an extremely important topic.  Naming beneficiaries can be one of the most valuable and effective ways to pass assets to a surviving loved one.  While discussing beneficiaries with clients, it is not unusual to hear preferences that seem harmless, but may have unintended consequences.

Here is one we sometimes hear (check out additional posts for others):

            “I’ll name one of my children because I know they will split it equally among my other kids.”

While this sounds simple and harmless, there are a few very important reasons why this is probably not a good idea. 

1. Tax consequences – if one child is named the beneficiary and they inherit your money, they will most likely be responsible for the full tax hit.  If your child inherits a taxable retirement account, they are responsible to claim withdrawals on their tax returns, and, depending on the account total, it could easily bump them up several tax brackets.  In this case, one child takes the full tax hit, while the others receive funds without tax consequence.
   
   
2. Legal consequences – if you name one child as beneficiary, legally, the money is 100% that child’s.  Even if you believe you have specified a split in your will or some other document, it will not matter.  Naming a beneficiary is a legal transfer of money and bypasses wills and court oversight.   While we all have faith in our children’s ability to be fair, circumstances can happen and everyone’s opinion of ‘fair’ becomes relative to their own situations.
   
   
3. Gifting consequences – this consequence is one that combines the previous two into a new twist.  If one child receives the money, it becomes their legal money.  If they give some of this money to someone else, it becomes a gift.  In 2019, the IRS allows us to gift up to $15,000 to any person and bypass some of the IRS reporting guidelines.  However, gifts above $15,000 become reportable.  It does not mean they are necessarily taxable, as that is another topic, but, at the very minimum, they must be reported to the IRS.

While it may feel like the easy thing to do, The Money Misstep is naming one child assuming they will split it with the others And How to Avoid It is to take the time to list each child and their appropriate share.  If you ever have questions about how your beneficiary selection may affect your situation, ask your accountant or a financial professional.  

Disclosure: This post is not intended to give tax or legal advice, speak with your tax or legal professional.