Understanding beneficiary designations: Common mistakes and how to avoid them

Naming a beneficiary may be one of the easiest ways to determine who will receive the assets in an account or insurance policy when you pass away – but it can be overlooked as part of financial and estate planning. A forgotten ex-spouse, a missing contingent beneficiary or an invalid designation can create delays, family conflict or other unintended outcomes.

Understanding how beneficiary designations work across retirement accounts, insurance policies and transfer-on-death accounts may help your assets move more smoothly to the people you want to receive them. Keep reading to better understand some common mistakes – and how to avoid them – when it comes to naming beneficiaries.

What are beneficiary designations, and why do they matter?

A beneficiary designation is a directive from the account owner that specifies who should receive the assets in the account upon the owner’s death. A primary beneficiary is the main person, persons or entity that you would like your asset to go to; a contingent beneficiary is a backup who would receive the asset should the primary beneficiary die or be unable to claim it at the time of distribution.

Beneficiary designations are commonly used for retirement accounts, such as 401(k)s and traditional and Roth IRAs, along with life insurance policies, annuities, health savings accounts (HSAs) and some bank or brokerage accounts with payable-on-death (POD) or transfer-on-death (TOD) features.

One reason beneficiary designations matter so much is that they often supersede instructions in a will. If you named one person as the beneficiary to your IRA but your will says something different, the beneficiary form will generally control how the IRA is distributed, not your will. This is why it is important to review your financial plan and make sure beneficiary forms and estate documents are aligned.

In many situations, these designations can also help assets transfer more quickly by avoiding probate – the court-supervised process that oversees the distribution of a person’s assets after they die. Beneficiary designations may also help reduce delays, lower administrative costs and/or minimize family disputes during an already difficult time.

Common mistake #1: Not updating beneficiaries after life events

One of the most common mistakes is failing to update beneficiaries after major life changes. These types of life events include marriage, divorce, remarriage, the birth of a child, the death of a beneficiary or even a job change.

This problem may surface years later. For example, someone may forget to remove an ex-spouse from an old 401(k), or a younger child may never get added after being born. Because beneficiary forms typically remain valid until updated, financial institutions generally follow the most recent signed designation on file.

To help avoid this issue, review beneficiaries every year and after every major life event. A quick annual review may help confirm that names and contact information are still accurate.

Common mistake #2: Missing contingent beneficiaries (or percentages don’t add up)

Many people may name a primary beneficiary but may forget to add contingent beneficiaries. Without a contingent beneficiary, the account may default to the estate or follow the financial institution’s distribution rules. If the primary beneficiary dies and no contingent beneficiaries are named, that may lead to probate delays or unintended outcomes.

Another issue involves percentages that do not add up to 100%. Even small errors may delay processing while the institution seeks clarification. For example, if you have your three children listed as beneficiaries at 33.33% each, that could cause a delay because the percentages add up to 99.99%. In this case, the percentage for one of the children would need to be 33.34% for the total to equal 100% exactly.

It may also seem logical to leave a specific dollar amount to each beneficiary, such as $50,000 or $100,000. However, account balances do not stay fixed, and if the account has lost value by the time you die, a set dollar amount could drain the account entirely for one beneficiary and leave nothing for the others. If the account balance has grown, the split may no longer reflect what you had in mind. Using percentages instead can keep things proportional regardless of the balance at the time of distribution.

Review whether a per stirpes option is available and appropriate. Per stirpes simply means a beneficiary’s share would pass to their descendants if that beneficiary dies before you. For example, if one of your adult children dies before you, that child’s portion could pass to their own children (your grandchildren) instead of being redistributed among surviving beneficiaries.

Common mistake #3: Naming minors incorrectly (and not planning for special needs)

Naming a minor child directly as a beneficiary can create legal complications because minors generally cannot directly control inherited assets until they reach the age of majority. When this happens, a court may need to appoint a fiduciary adult to manage the money until the child reaches the age of majority, which varies by state. That process can add costs or delays and may put someone in charge that you did not want.

Instead of naming the minor child directly, it may be better to set up a trust for the minor child. This allows you to appoint a trustee to manage the assets and even outline how you would like the assets to be used until the child reaches the age of majority.

Special needs planning requires even more care. Leaving assets directly to a person with disabilities could unintentionally affect eligibility for certain government benefits. A special needs trust may be an appropriate structure, allowing you to leave assets for their benefit without disrupting their current eligibility.

Because these situations can be legally complex, it is often advisable to consult an estate planning attorney when minors or special needs beneficiaries are involved.

Common mistake #4: Poor coordination with trusts, wills and accounts

Even people with solid estate plans can make this mistake. If your beneficiary forms on file with your financial institutions still reflect old instructions, your updated estate plan may not play out the way you intended. Rollovers and account retitling can create problems, too. Someone who consolidates retirement accounts after leaving a job may assume beneficiaries automatically transferred to the new account when they did not. In both instances, beneficiary forms need to be updated to match the updated will, trust or account.

Another common issue is accidentally naming the estate as beneficiary. While that may make sense in limited situations, it may also expose assets to probate and potentially create additional tax implications. Generally speaking, directly naming the individuals or entities you want your assets to go to may help shield them from creditor claims and potentially reduce the taxes owed.

Lastly, when establishing a trust, you must include specific legal names, dates and trustee references in the trust document to make sure it is valid. Naming a primary and successor trustee can limit any future disputes over how the trust will be managed. Additionally, make sure that beneficiaries of your trust match the designations of the individual assets in the trust.

Where to update your beneficiaries for different accounts – and pitfalls to avoid

The process for designating your beneficiaries depends on the type of asset in question, and some common issues tend to arise when it comes to certain accounts. Here’s a look at who will likely be your main point of contact for updating your beneficiary designations and some potential mistakes to prevent for various account types.

How to avoid beneficiary mistakes: A simple checklist

The good news is that most of these mistakes are preventable. Here is a checklist to help you keep things on track.

What you can do right now

What you can do after major life changes

What you can do every year

The bottom line

Beneficiary designations are one of those things most people set up once and never think about again. But these forms often carry more legal weight than your will, directly naming who inherits certain accounts and assets when you pass away. If they are outdated, your assets may not end up with whom you intended.

The mistakes that can cause the most grief are usually simple ones: an ex-spouse from a marriage that ended years ago still listed as a beneficiary, a new child left off a form or a minor named directly without the right structure in place. These may not take long to fix, but left unaddressed, they may create real complications for the people you are trying to protect. Making beneficiary reviews a regular habit, particularly after any major life event, and potentially working with an estate planning attorney are a few things you can do to make sure your wishes are carried out.

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