Understanding How Beneficiaries Work

As a financial advisor, I used to review client’s paperwork when they came in for an appointment. Among many other things, I always made sure to go over was to review beneficiaries of my client’s accounts. Or, more to the point, I TRIED to review the beneficiaries on my client’s accounts. All too often, they had no idea who the beneficiaries were, or how to find out. Even worse, they often just decided to assume that they knew the beneficiaries on their accounts.

Out of date beneficiaries is one of the most common financial problems people have when they start financial planning.

What Are Beneficiaries

When someone dies, there are a series of laws that determine exactly how your assets get dispersed among the living. These laws are long and complex. They are collectively referred to as estate law, and it is complicated enough to be an entire specialty for attorneys. The primary instrument for distributing your assets as you see fit, rather than as how the law dictates, is your will. However, there are several kinds of accounts that do not fall under this process, unless you do not properly designate your beneficiaries.

beneficiary trouble

In this context, a beneficiary is the person who will receive some, or all, of the money or assets contained within certain kinds of accounts. The special thing about beneficiaries is that they are not subject to the traditional estate process. This is what many people do not understand. Your designated beneficiaries have nothing to do with your will, your trustee, or any sort of probate at all. They will receive the assets completely outside of this process.

In other words, a beneficiary designation trumps normal estate law.

In order to ensure a full grasp of what this means, some examples are helpful.

Beneficiary Example 1: A man has $500,000 in total assets. $300,000 are in an account with beneficiaries and $200,000 are in various other financial accounts. The first account has the man’s son listed as the only beneficiary. The man’s will says that all of his assets should be split 3-ways between his three children. How much does each child get?

Under the terms of the will, you might thing that each child gets one-third of the $500,000 in total assets. However, this is not what happens. Having a beneficiary takes those assets out of the estate process altogether. So, in this case, the will splits up only the $200,000 that remains. The three children split that money equally. The son listed as the beneficiary gets not only his one-third share of $200,000, but all of the $300,000 account he is listed as a beneficiary on.

  • The son listed as the beneficiary gets $300,000 + 1/3 of $200,000 ($66,667) = $366,667
  • The other two children get $66,667

Is that what you expected?

Beneficiary Example #2: A woman has an account with $100,000. The beneficiary is her husband. Years later, she divorces him and remarries. The woman visits her attorney and updates her will to state that none of her assets go to her ex-husband and that her current husband should inherit everything.

When the woman dies, the $100,000 still goes to her ex-husband, and there is nothing the current husband can so or do about it. The named beneficiaries of an account takes precedents what the will stipulates.

Beneficiary Example #3: A man has an account that lists his two children, Steve and Jane, as beneficiaries in equal amounts. Steve dies before his father. The father never updates the account. When the father dies, how much does Jane receive?

This is where it gets really complicated, because there are different types of beneficiaries.

Not updating beneficiaries is one of the major mistakes people make when doing financial planning. The problem is that people don’t think about beneficiaries unless they are doing estate planning, which focuses on the drafting of wills and trusts. Ensure that you review all of your account beneficiaries regularly and share that information with your financial planner and estate attorney so that everything happens the way you desire.


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