Beneficiary Designations: When and Why They Matter and When to Review Them

Beneficiary designations determine who receives certain assets when an account holder passes away. These designations apply to retirement accounts, life insurance policies, annuities, and some brokerage accounts. Many investors complete these forms when opening an account and may not revisit them for years. Outdated or incorrect designations may result in assets passing in ways the account holder did not intend. As part of our financial-planning process, we help clients identify accounts with beneficiary designations and consider whether those designations still reflect their stated intentions. Here’s what to know about how they work, when to review them, and why they matter.

How Beneficiary Designations Work

Beneficiary designations are instructions attached to specific accounts that direct who receives the assets upon the account holder’s death. For many accounts, a valid beneficiary designation generally controls who receives the account, regardless of contrary instructions in a will. The applicable plan documents, account agreement, federal and state law, spousal rights, and court orders may affect the ultimate result. This is an important distinction that many investors may not fully appreciate.

Common accounts with beneficiary designations include 401(k) plans, IRAs, life insurance policies, annuities, and transfer-on-death brokerage accounts. When completing these forms, account holders name primary beneficiaries who receive assets first. Contingent beneficiaries receive assets if primary beneficiaries are unavailable or have predeceased the account holder.

Because these designations pass assets directly to named individuals or entities, the assets typically bypass probate. This may simplify the transfer process, but it also means that errors or outdated information on these forms may have significant consequences.

Life Events That May Warrant a Review

Certain life events typically signal that a review of beneficiary designations may be appropriate. These include:

1. Marriage or divorce. Marriage may create spousal rights in certain retirement plans, while divorce does not necessarily produce the same result for every type of account. Beneficiary forms, plan documents, divorce decrees, and any qualified domestic relations order should be reviewed with the appropriate legal professional..

1. Birth or adoption of a child. New family members may need to be included in estate and beneficiary planning.
2. Death of a named beneficiary. If a primary beneficiary passes away, the contingent beneficiary designation becomes more important. If no eligible beneficiary remains, the account will pass according to the default provisions in the applicable plan or account agreement, which may result in payment to the estate or another default beneficiary
3. Changes in family relationships. Estrangements, reconciliations, or changes in how an investor wishes to distribute assets may warrant updates.
4. Retirement or job change. Rolling over an employer-sponsored plan may require completing new beneficiary forms with the receiving institution.
5. Creation or update of an estate plan. Beneficiary designations should generally be reviewed when wills or trusts are created or revised to help ensure alignment.
6. Moving to a different state. Some states have community property rules that may affect spousal rights to retirement accounts and other assets.

Common Issues With Outdated Designations

Several issues may arise when beneficiary designations are not kept current. Ex-spouses may remain listed as beneficiaries after divorce. Deceased individuals may still be listed as primary beneficiaries without contingent beneficiaries named. Minor children named directly as beneficiaries may require court involvement to manage inherited assets.

Designations may also conflict with intentions expressed in a will or trust. Because beneficiary designations typically take precedence, the will may not control how these assets pass.

Considerations for Different Account Types

Different account types have different rules and considerations regarding beneficiary designations.

1. Retirement accounts (401(k), IRA). These accounts are subject to required minimum distribution rules for beneficiaries. Spousal beneficiaries generally have different options than non-spousal beneficiaries. The SECURE Act, enacted in 2019 and modified in subsequent legislation, changed distribution requirements for many inherited retirement accounts. Many non-spouse designated beneficiaries of retirement accounts inherited after 2019 must fully distribute the account by the end of the tenth year following the owner’s death. Depending on the beneficiary’s status and whether the owner died before or after the required beginning date, annual distributions may also be required during that period. Different rules apply to certain eligible designated beneficiarie
2. Life insurance. Proceeds pass directly to named beneficiaries and are generally income tax-free to recipients. However, proceeds may be subject to estate tax considerations depending on ownership structure and the size of the estate.
3. Annuities. Beneficiary options may vary by contract. Tax treatment of inherited annuities depends on whether funds are qualified or non-qualified and how distributions are structured.

4. Transfer-on-death brokerage accounts. These accounts pass directly to named beneficiaries outside of probate. Cost basis considerations may apply. Inherited taxable assets generally receive an adjusted basis based on their fair market value at death, although exceptions and special valuation rules may apply.

 

How Beneficiary Designations Fit Into Estate Planning

Beneficiary designations should be reviewed alongside wills, trusts, and other estate planning documents. Working with an estate planning attorney and a financial advisor in Chicago may help ensure that designations align with overall intentions.

Some investors use trusts as beneficiaries for specific purposes, such as managing assets for minor children or beneficiaries with special needs. However, naming a trust as beneficiary may have tax and distribution implications, particularly for retirement accounts.

How We Approach This With Clients

At Virtue Asset Management, we include beneficiary designation review as part of our financial planning process. We work with clients to identify accounts with beneficiary designations and review whether they reflect current intentions. We coordinate with clients’ estate planning attorneys as appropriate. We do not provide legal advice but work alongside legal professionals to support an aligned approach.

For investors seeking a financial advisor in Chicago or evaluating financial advisors in Chicago, Virtue Asset Management is an independent, fee-only investment adviser registered with the U.S. Securities and Exchange Commission. We provide investment advisory services on a fee-only basis and act as a fiduciary for those advisory services. Virtue Asset Management does not provide tax or legal advice; clients should consult their tax professional and estate planning attorney. Not all services are available to all clients, and services are provided pursuant to the terms of each client’s advisory agreement.

Disclosure: This material is provided for general informational and educational purposes only and should not be construed as individualized investment, tax, accounting, or legal advice. Beneficiary and estate-planning outcomes depend on individual circumstances, applicable law, plan documents, account agreements, and other factors. Virtue Asset Management does not provide legal, tax, or accounting advice. Please consult the appropriate legal and tax professionals regarding your circumstances.

Additional information about Virtue Asset Management is available in its current disclosure documents, Form ADV, Form ADV Part 2A Brochure, and Form CRS (Client Relationship Summary), which are accessible online via the SEC’s Investment Adviser Public Disclosure (IAPD) database at www.adviserinfo.sec.gov, using SEC file number 801-123564.

Virtue Asset Management is neither an attorney nor an accountant, and no portion of this content should be interpreted as legal, accounting or tax advice.