By Russell W. Hall, CFP®

Behold…the beneficiary designation.  Capable of passing your assets along to your loved ones exactly as you would like, but able to ruin the most well-thought-out estate plan if you’re not careful.

The Basics

Naming beneficiaries is a relatively simple way to direct where your retirement and some other types of accounts will go when you die.  You can name individuals, charities, or even entities like a trust.

It seems straightforward enough, right?  A common scenario for a married couple is to name each other as the 100% primary beneficiary of their IRAs, with their two grown children as equal 50% contingent (also called secondary) beneficiaries.  If both spouses passed away at the same time, their children would each receive half of the IRA accounts in the form of inherited IRAs.

Details, Details

Where the “fun” begins is when things aren’t so clear cut.  What if it’s a second marriage for the couple and they each have children from a previous marriage? 

What if they want to leave some of the IRA money to a charity?

What if the children are minors?  Or grown and married?  What if the parents don’t like who their kids are married to?

Some of these problems – minor children, disabled beneficiaries, excluding a child’s spouse - usually should not be solved with just a beneficiary designation form.  It might be best to name a trust as the beneficiary where more complicated issues can be ironed out.  See our article for more information about naming trusts.

But there are ways to modify a beneficiary designation form to make it more flexible if the situation calls for it.  One solution is to use per capita or per stirpes.

It’s All Latin

Per capita means “by head”, and it refers to splitting up the account among the remaining living beneficiaries but not any of their heirs. 

If all of the 3 grown children were alive when their parents died, they would get their share of the IRA (about 33.3%).  However, if one of them has already passed away, their two siblings would then get 50% of the account and the deceased child’s family would get nothing.

The other option is per stirpes, meaning “by representation”.  Each beneficiary’s portion is assigned to them and also to their heirs if they died.  In our example, if one of the children had already passed away, the two living children would get their 33.3% and the family of the deceased child would get 33.3%.

Be aware that custodians can interpret per capita and per stirpes differently, and some even have other options.  If in doubt, we suggest checking with your financial advisor or estate planning attorney to make sure the paperwork is being completed correctly.

Don’t Set it and Forget it

Sometimes, people tend to treat estate planning as if they only have to do everything once and then let it sit.  The problem is that life changes, and it’s best to review your documents every 7-to-10 years to make sure they still reflect your wishes.

This is especially true for beneficiaries.  The courts have stated time and time again that the named designation overrules all other estate planning documents, including wills and trusts.  It’s happened too often that an ex-spouse received an entire IRA account because the beneficiaries were not updated after a divorce.  Children have been left to deal with large tax bills, or have had to go through the extended and expensive probate process, because their parents did not take the time to designate a beneficiary. 

Your Task

We’ll close with something we said in a previous article:

As with many things, you often don’t know there’s an issue with estate planning until it is actually put to use (when it’s too late to fix, or at best expensive and time-consuming to do so).

This is worth repeating and considering.  Go check your beneficiary designations!

Schedule a 15-minute discovery call with a fee-only financial advisor if you want help thinking through some of these issues.