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Beneficiary Choices Are Confusing. Here’s a Simple Guide for Selecting Beneficiaries.

Aug 4th, 2020 • Damian Dunn

I changed jobs recently and was completing paperwork to get enrolled in my new employer’s 401k. What should I consider when I’m completing my beneficiary choices? Any suggestions?

Kate


Ahhh, beneficiaries. This is an often neglected section on 401k enrollment forms. A surprising number of people don’t list anyone as a beneficiary, and that can cause problems in the future. Even if a primary and contingent beneficiary are provided when the employee signs up, life happens and they might need to be changed. Let’s look at some of the ins and outs of designating a beneficiary. 

First, what is the difference between a primary and contingent beneficiary? The person (or persons) listed as the primary beneficiary will be given the assets in the account before any contingent (or secondary) beneficiary would have a claim to them. For example, if you were to list your spouse as a primary beneficiary with 100% of the assets going to them and your sibling as a contingent beneficiary with 100% of the assets going to them, as long as the spouse survives you, they’ll inherit the entire account. If your spouse were to pass before you and you didn’t update your beneficiary designations, then your sibling would inherit the account at your passing. 

You’ll notice that I italicized the part about updating your beneficiary designations in the previous paragraph. I did that because: 

1) it doesn’t happen as often as it should 

2) it can lead to unintended consequences. 

Let me share an example with you. Kate, I don’t know if you’re married or not, but I’m going to pretend you are. Actually, you’re on your second marriage and so is your spouse. Sadly, your spouse meets an early, and unexpected, demise in a horrible bird watching accident. As you’re discussing things with the estate attorney, you discover that your dearly departed never updated their beneficiary designations and that their ex-spouse is still listed as the primary beneficiary. Yikes! 

You are allowed to update your beneficiaries at any time, so there isn’t any reason to find yourself (or for your loved ones to find themselves) in an unintended situation.

Next, let’s say you’ve found love again and are married for a third time. Congratulations! You decide that you’d like to make your two kids the primary beneficiary of your 401(k) at work with each of them getting 50% of the balance. You’re certainly able to do that… after your spouse signs off on it. Any account that falls under the guidance of the Employees Retirement Income Security Act (ERISA), which a 401(k) does, is required to list the spouse as a primary beneficiary for at least 50%. If the account owner wants to list individuals other than their spouse as primary, or give their spouse less than 50%, the spouse will be required to sign a spousal waiver before the beneficiary designations will be accepted by the custodian. 

If you’d like to leave your account to your minor children, that’s fine, but you’ll need to appoint a guardian to assist them since they can’t inherit the money directly. If you don’t designate someone, the court will. I could very easily take this rabbit trail over the next hill discussing the importance of estate documents, specifically a will and possibly a trust in this case, but I’ll pass (for today). 

Finally, you’ll want to designate beneficiaries because it allows the account to pass outside of probate. Probate is the legal process of making sure a person’s debts and assets are handled appropriately after they die. If your retirement account has designated beneficiaries, the instructions are clear on who you wanted to inherit those assets. Therefore, by law, that money can pass to your beneficiaries directly and skip the probate process. 

Make sure you review your beneficiaries at least once a year and when any major life event happens (marriage, death, birth, adoption, etc.). It may not be an exciting part of your personal financial life, but it is one of the most important. 

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