The Beneficiary Designation Mistake That Costs Families Thousands

Your beneficiary designations are among the most important documents you have. They control what happens to your retirement accounts, life insurance proceeds, transfer-on-death accounts, and various other assets when you pass away. They override your will. They can move assets directly to a beneficiary outside of probate, which can be efficient. But they can also create unintended consequences if they are not aligned with your actual wishes and your overall estate plan.

The Most Common Mistake: Outdated Designations Someone opens an IRA 30 years ago and names their spouse as the beneficiary. They get divorced 15 years later, but they never updated the beneficiary designation. They remarry. They pass away. Their IRA goes to the ex-spouse, because that is what the designation says. This happens often, and it is entirely preventable. Life events — marriage, divorce, birth of children or grandchildren, death of someone you named — should trigger a review of beneficiary designations. Many people do not make these connections. They update their will but forget about beneficiary designations, which actually have more control over asset distribution than a will does.

Mistake 2: Not Accounting for Unequal Distributions Imagine a parent with two children, both of whom they love equally. In their will, they specify equal distribution. But their IRA is worth significantly more than the rest of their estate, and they only named one child as IRA beneficiary (perhaps because that child helped them with finances). Now one child receives a large IRA, the other receives a smaller amount from the rest of the estate. The parent thought they were being equal; they were not. The IRA beneficiary also gets a tax deferral advantage that the other beneficiary does not. This creates resentment and appears unequal, even if it was unintentional. The solution is to coordinate. Either name multiple children as IRA beneficiaries (splitting the IRA among them), or adjust the will to account for the unequal distribution, or make the distributions equal and clear the intent in writing.

Mistake 3: Naming an Estate as Beneficiary This is a more technical mistake, but it is worth understanding. When you name your estate as the beneficiary of an IRA or retirement account, a few things happen. The asset goes through probate, which costs money and takes time. Second, and more important, the income tax treatment changes. If a non-spouse beneficiary inherits an IRA, they now have to take distributions based on their life expectancy (called 'stretch IRA' treatment, though recent law changes have limited this). But if the account goes to the estate, the beneficiary loses that tax deferral advantage. The money comes out faster, and more of it is taxable. There are very few situations where naming an estate as beneficiary makes sense. Usually, it is a mistake.

Mistake 4: Naming a Minor Child as Beneficiary If you name a child under age 18 (or sometimes under age 21 or 25, depending on your state) as a beneficiary of an IRA, and you pass away, the minor cannot legally receive and control a large sum of money. A court-appointed guardian would have to manage it. This is inefficient and expensive. The solution is to name a trust as the beneficiary, with the minor as a beneficiary of the trust. The trust can set terms — hold the money until the child reaches age 25, distribute some at age 21 and the rest at age 30, whatever makes sense. This requires the trust to be properly drafted (which costs money and requires an attorney), but it is vastly preferable to leaving a minor child with direct control of a large sum.

Mistake 5: Per Stirpes vs. Per Capita — and Not Knowing Which You Chose If you name a beneficiary and that beneficiary predeceases you, what happens to the money? Does it go to that person's children (per stirpes, 'by the branch'), or does it go to other beneficiaries you named (per capita, 'by the head')? The rules differ, and they differ among different types of accounts. If you have not thought about this, you might not know what you chose. This matters, and it requires a deliberate decision.

Mistake 6: Using Beneficiary Designations as a Substitute for a Will Some people assume that because they have named beneficiaries on their retirement accounts, they do not need a will. That is not how it works. Beneficiary designations cover specific accounts. A will covers everything else — your home, your car, your personal property, custody of minor children, who serves as your executor. You need both. Worse, if someone names beneficiaries but has no will, and something happens to those beneficiaries (or if the beneficiary designations are unclear), the assets fall into intestate distribution, which is controlled by state law, not by your wishes.

What a Good Designation Looks Like Here is what we typically recommend: First, name specific individuals or entities as primary and contingent beneficiaries. 'My spouse' is not specific enough — what if your spouse is not married to you anymore? Use full names and Social Security numbers if possible. Second, specify percentage splits. '50% to my spouse, 25% to each of my children.' Third, think about what happens if one beneficiary predeceases you. Do you want their share to go to their children (per stirpes) or to the other named beneficiaries? Fourth, if a minor or spendthrift child is a beneficiary, consider naming a trust. Fifth, coordinate with your will and your overall estate plan to ensure distributions are aligned with your intent and tax-efficient. Sixth, review this every few years and after any major life event.

A Final Note Do not assume that your current designations are correct just because they have been in place for years. Pull up your statements. Check what is actually named. If anything looks wrong or outdated, contact your custodian and update it. For Tampa Bay families with significant retirement savings, a few hours spent reviewing and updating beneficiary designations can prevent years of confusion and thousands of dollars in unnecessary costs to your heirs.