People can be surprisingly nonchalant when it comes to beneficiary designations on retirement accounts and life insurance policies. They assume even if they have missed a beneficiary designation or it is out-of-date, the remaining account balance will automatically go to their surviving spouse or children upon death.
However, a recent survey done by the National Investment Company Service Association (NICSA), reveals that there is little consistency among IRA providers as to how default IRA beneficiary designations are handled. According to the survey, the default beneficiary will vary widely depending on the provider. For example, 43% of accounts default to a surviving spouse, then the estate; 30% default to the account owner’s estate (not a spouse or children); and only 22% percent default automatically to a spouse, then the children, then the estate. To complicate matters, many people have multiple IRAs at more than one institution, which means the default beneficiary treatment of each account will vary.
A beneficiary designation on an IRA or other retirement account is critical because retirement accounts are automatically excluded from an account owner’s probate estate as long as the account has at least one person designated as the beneficiary who survives the account owner. If there is no then living beneficiary, the account is deemed to have no beneficiary and it must be paid to the deceased owner’s estate. This has two very bad effects: First, a probate estate has no life expectancy and, consequently, the account has to be liquidated, which can result in a significant income tax bill; Second, because the account must be paid to the owner’s estate, it becomes subject to the claims of the owner’s creditors – and the creditors enjoy a prior right to the funds ahead of surviving family members, even a spouse.
IRA providers will include default beneficiary designation clauses in their account agreements so that if the account owner fails to designate a beneficiary before death, or the designated beneficiary dies before the account owner, the balance in the account will still pass to a default beneficiary per the account agreement. But as the survey shows, you cannot assume who that beneficiary is, and there’s a nearly 1-in-3 chance the default beneficiary will be the owner’s estate.
I’ve seen too many cases where a retirement account or life insurance benefits passed to an unintended beneficiary, and it’s next to impossible to correct something like that after the owner’s death.
One of the homework assignments I give to all of my planning clients is to verify all of their beneficiary designations on each of their retirement accounts and life insurance policies. It is very common for clients to come back to my office having discovered that they missed a beneficiary designation or one or more were out-of-date. At least they have a chance to correct them.
So, don’t leave it to chance. Do your homework and make sure your beneficiary designations are up to date.