Certain financial accounts can transfer directly to the people named as beneficiaries, rather than being distributed through your estate. Retirement accounts such as 401(k)s and IRAs, along with life insurance policies, are generally governed by beneficiary designations. The financial institution typically follows the beneficiary information on file rather than relying on instructions contained in your will or other estate documents.
The Supreme Court highlighted how strictly these designations can operate in Kennedy v. DuPont. In that case, a Texas man divorced in 1994, and his former wife gave up her interest in his retirement plan as part of the divorce agreement. However, he never changed the beneficiary designation. After his death, the retirement plan paid his former wife the approximately $400,000 balance. The Supreme Court unanimously upheld the payment, illustrating that federal rules governing certain workplace retirement plans can require administrators to follow the designation on record even when other legal documents say something different.
There are less dramatic ways an outdated beneficiary designation can create problems. If the person you named as your beneficiary dies before you and you have not selected a contingent beneficiary, the account may ultimately become part of your estate and potentially go through probate. One of the advantages of beneficiary designations is that they can allow eligible assets to pass directly to the named recipient.
Updating your designations does not have to be complicated. Make a list of every account that allows you to name beneficiaries, including retirement plans, pensions, life insurance, annuities, health savings accounts and bank or investment accounts with payable-on-death arrangements. Review each account individually, confirm that the primary beneficiary reflects your current wishes and add a contingent beneficiary whenever the account allows it.
Do not overlook retirement accounts from previous employers. A 401(k) you left behind years ago still follows the beneficiary information recorded with the plan unless it has been changed or otherwise transferred. For many workplace retirement plans, federal law also provides special protections for spouses, and a spouse may generally need to provide the required waiver before someone else can be designated as the primary beneficiary. The exact requirements depend on the type of plan.
Many financial institutions allow beneficiary information to be reviewed and changed online, making the process relatively quick. For more complicated estate situations, however, professional legal or financial advice may be appropriate.
After completing the review, set a reminder to check your beneficiary designations again in a few years and whenever a major life event occurs. Your will explains how you want your estate handled, but beneficiary forms can control the distribution of accounts that pass directly to named beneficiaries.
