Beneficiary designations can be a useful tool in estate planning. When a beneficiary is named for, say, a life insurance policy, this asset does not go through probate. You simply list who gets the money upon your death. When you pass away, the policy is paid directly to the beneficiary. No court involvement is needed through probate. However, the simplicity of beneficiary designations can lead to some problems if not done correctly.
Mistake #1 – Not making a selection
The first mistake people make is not completing a beneficiary designation form at all. A spouse and children are not automatic beneficiaries of your IRA or life insurance. A signed beneficiary form must be submitted to the company. If a beneficiary is not designated, the asset will go through the probate process.
mistake #2 – not making timely updates
Secondly, people often do not update forms. They complete a beneficiary designation when they purchase a life insurance policy. However, they fail to update their beneficiaries in the future. Forgetting to update a beneficiary designation can lead to a child being unintentionally disinherited. Similarly, people fail to name a contingent beneficiary. They name their spouse; however, they never get around to naming their children. Unfortunately, this asset will go through probate. Furthermore, if it is an asset such as an IRA, it will be liquidated which will lead to this asset being immediately taxed.
Mistake #3 – naming a minor
The most common mistakes I see when it comes to beneficiary designations are naming a minor as a beneficiary and failing to create creditor protection for the beneficiary. First, if you name a minor as a beneficiary, the asset will be held and controlled by a guardian. The minor will then have access to the asset at age 18 regardless of your wishes. Also, generally, people put very little thought into creating creditor protection for the beneficiary. The beneficiary may be very poor with money management have special needs or be in the middle of a divorce.