Whether you have an estate plan or not, it’s almost a certainty that you have some assets (e.g., an IRA, life insurance, etc.) that will rely on a beneficiary designation to transfer to the proper beneficiaries. Unfortunately, many misunderstand how a beneficiary designation form works, and sometimes this prevents the assets from passing to whomever the original owner intended.
Beneficiary designation forms typically allow you to choose primary and contingent beneficiaries. The misunderstanding occurs when the contingent beneficiaries come into play. Many believe that the asset first goes to the primary beneficiary, and later to the contingent beneficiary. This is not correct.
Mary has an IRA and chooses her daughter Jane as the primary beneficiary, and her two grandchildren (Lisa and Michael) as 50% contingent beneficiaries each on her IRA beneficiary designation. Jane is married to Tom, but Mary is not the biggest fan of her son-in-law. When would Mary’s grandchildren Lisa and Michael receive their share of the Mary’s IRA?
If Mary’s daughter Jane predeceases her (e.g., the primary beneficiary predeceases the account owner), then Lisa and Michael would each inherit 50% of Mary’s IRA as Mary intended.
But what if Jane survives her mother—as one would typically expect—and then passes away afterward? Does Mary’s beneficiary designation come into play? Not at all.
If Jane survives her mother, the IRA becomes Jane’s inherited IRA and upon Jane’s death, will go to whomever Jane has chosen as her beneficiary, or if she hasn’t chosen anyone to her heirs as determined by her Will or the state where Jane lives. In most cases, that will be her husband Tom, not the grandchildren Lisa and Michael.
Even if Mary chooses Jane “per stirpes” or “per capita at each generation” (two legal terms that essentially mean if the beneficiary is deceased, the asset should flow to the beneficiaries’ descendants), the “per stirpes” and “per capita at each generation” designation becomes moot once Jane inherits the IRA. Upon Jane’s death, the asset will transfer based on Jane’s plan, not Mary’s beneficiary designation form.
There is one sure way to ensure your assets remain within your bloodline—make the beneficiary a trust that leaves your beneficiaries their inheritance in trust (and not outright).
It’s fine and helpful to use beneficiary designations—but it is important to understand how they truly work.
Stay tuned soon for another common error people make in choosing their beneficiary designations.