In our most recent Wealth Management Insights publication, Scott Christianson, CFP®, explained the importance of beneficiary designation in estate planning and the different options to ensure that assets are distributed to the intended heirs.
by Scott Christianson, CFP®
Executive Vice President
Portfolio and Wealth Management
One of the most prevalent areas where an estate plan can fall through the cracks is when a beneficiary designation misaligns with the rest of one’s estate plan. As such, having beneficiaries set ahead of time and in conjunction with the rest of your plan is an important first step to avoiding this common pitfall. Beyond that, factoring in what might happen if one of the primary named beneficiaries is not available to inherit assets is a prudent second step.
Just like your living will or trust will likely have contingencies factored in, including a contingent beneficiary should be considered for beneficiary designated accounts such as an IRA, 401k or life insurance policy. On the surface, naming a contingent beneficiary may appear to be a straightforward election. However, doing so can also bring complexities depending on what elections are made. This stems from what is or isn’t selected on the beneficiary designation forms, the critical piece of documentation that directs who inherited the assets, which are on file with the custodian.
If no further election is made on the beneficiary designation form, the custodian will typically apply a default distribution setting. If there are multiple primary named beneficiaries, it’s important to be aware of this default setting, its impact and how it directs the distribution of assets to heirs, and at times, creates unintended consequences. Frequently known as “per capita” (by children), this default setting will effectively remove a branch of the family tree if one of the named primary beneficiaries has died and the beneficiary designation is not updated. The remaining primary beneficiary (or beneficiaries) inherit the assets as depicted in the accompanying graphic. If this default election is in force and the beneficiary designation is not updated, the children of the deceased primary beneficiary will not inherit in their stead, which may be unintentional and damaging for the family. Each custodian will have its own default rules, so it is critical for an owner to be aware of the impact of such rules with each custodian with whom they hold assets.
Image source: Ferguson Wellman Capital Management
A common estate planning goal is to distribute assets to all branches of the family. To accomplish this, a bit of contingency planning is needed. This can be done through an election on the beneficiary designation form. The options generally fall under the two categories: “per stirpes” and “per capita” (by heir). Each option is unique, but in both cases, they ensure assets pass to an heir’s next generation should one of the named primary beneficiaries be deceased.
Image source: Ferguson Wellman Capital Management
In the case of a per stirpes designation election, the most common of the two options, the heirs would receive a distribution of assets by family lineage. The heirs down the family branch would receive a distribution based on the share of the deceased primary beneficiary.
A per capita (by heir) election is a less common beneficiary option providing for the heirs of a deceased primary beneficiary. Like per stirpes, heirs further down the family line are included in the distribution. However, the key difference is in how the share received by the heirs is calculated. In the case of per capita (by heir), all beneficiaries get a proportional amount based on the total number of living beneficiaries. This is contrary to the per stirpes election where the deceased primary beneficiary share is divided among their heirs.
Image source: Ferguson Wellman Capital Management
Each asset controlled by a beneficiary designation will have its own beneficiary designation forms, and the respective custodian will keep this record on file for each account. If you have multiple accounts that have their own respective beneficiary designations, it is advisable to keep a record of these with your estate planning documents.
When you pass away, a beneficiary designation becomes the guiding document to distribute those specific assets to heirs. Making certain that these critical designation forms are in line with the rest of your estate plan, are up to date and reflect your wishes is key. Though never a pleasant topic to consider, putting in place estate planning contingencies is an important part of planning for an alternate scenario. Understanding the key elections made in a beneficiary designation can help prevent an unintentional distribution (or lack thereof) to your heirs.
To read the entire publication, click the button below.