Basics of Designating Beneficiaries
Most retirement plans, annuities and life insurance policies let you decide what should become of your assets in the event of your demise through the designation of beneficiaries. The primary beneficiary or beneficiaries inherit first. If they are dead or they die with you, your assets go to any secondary beneficiaries you have named.
You will need to name names. And you will need to determine what percentage of your assets go to each beneficiary.
Beneficiaries can include those who leap to mind -- spouses, children and other relatives. Or they can include friends, trusts, charities and institutions.
Beneficiary designations generally kick in immediately after death and override a will. That means your assets will not have to go through probate, a legal proceeding that can be expensive. But it also means that you need to ensure that your beneficiary designations reflect your most recent wishes because your will cannot override them.
Considerations in Designating Beneficiaries
Spouses can generally inherit assets from one another without generating estate taxes or, in the case of retirement accounts, being forced into taking mandatory taxable payouts. (Unless the inheriting spouse has turned 70 1/2, in which case normal distribution rules apply.)
Other heirs, though, may face some consequences.
Loading too many assets on to some heirs may make their own estates liable to the federal estate tax. Assets up to $2 million are exempt in 2008; up to $3.5 million in 2009. The tax, also known as the "death tax," is set to vanish in 2010. Anyone affected by it, however, will have to pay 45% of every dollar in assets they own above the cap. Keeping your potential heirs informed of your intentions allows them to plan accordingly.
Many types of retirement plans, including 401(k)s and most forms of individual retirement accounts, will force your beneficiaries to take the money now and pay income taxes on the full amount, or take required taxable distributions every year in amounts that are based on Internal Revenue Service life expectancy tables. Roth IRAs are exempt because you have already paid taxes on the money in them.
One way to avoid taxes on your inheritance altogether is to designate a charity or a non-profit group, such as a university foundation, as your heir. There's no tax on the transfer or on the future use of your money.
Children and Other Considerations in Designating Beneficiaries
Underage children, who may include anyone up to age 21 in some states, cannot directly inherit assets from an annuity, a retirement plan or a life insurance policy. Consult with an attorney, if necessary, to set up trusts for them, which can then be named in your beneficiary list.
You may also need to create trusts for beneficiaries with mental disabilities, if they are unable to handle their own affairs.