What Is a Beneficiary?
A beneficiary is an individual designated to receive the belongings or assets of another person after that person’s death. Beneficiaries often receive these benefits as an inheritance.
A beneficiary can be designated in the documents relating to a life insurance policy, a retirement account, a brokerage account, a bank account, and other financial products.
It’s important to designate beneficiaries for your financial assets so that they can be distributed according to your wishes when you pass away.
Key Takeaways
- A beneficiary can be an individual who receives a benefit, often a monetary distribution, from another.
- Distributions can have tax consequences.
- Beneficiaries who inherit a retirement account must understand the option they have for the distribution of its funds.
- Options for distributions from inherited IRAs depend on whether the beneficiary is an eligible designated beneficiary or a designated beneficiary.
- You can change the beneficiaries of financial accounts at any time, though doing so requires completing and returning the relevant paperwork.
Investopedia / Julie Bang
Understanding Beneficiaries
Any person or organization can be named a beneficiary of someone’s property.
The individual who owns the property or the benefactor can put various stipulations on the disbursement of the property. These might include the requirement that a beneficiary is a certain age or is married before taking control of the inherited property.
There can be tax consequences for the beneficiary when inheriting certain financial assets. For example, if someone is the beneficiary of a life insurance policy, it’s useful to know that while the principal of most policies is not taxed, the accrued interest might be.
Beneficiaries on Financial Accounts
Failure to name beneficiaries for your financial accounts means that the assets of your accounts must be distributed through your will.
If you designate beneficiaries in the paperwork of the financial accounts, the accounts or their value pass directly to those individuals, avoiding probate.
Beneficiaries designated on the paperwork for financial accounts override any beneficiary listed in a will.
Beneficiaries in a Will
Failure to name beneficiaries in a will can tie up your property in probate, potentially for years. It can leave the decision about how to distribute your assets up to the state in which you live.
In such a case, the people for whom you wanted to provide financial support after your death may not receive it. Or they may have to wait a long time for it.
Warning
When you pass away without a will in place, you’re deemed intestate and your assets are distributed not necessarily to your chosen beneficiaries but according to state inheritance laws.
Why Beneficiaries Are Important
It’s important to designate beneficiaries for your financial property so that you can feel confident that the people you’ve decided your money should go to are assured of receiving it.
- By naming beneficiaries, you control what happens to your money and clarify the matter for all who may be involved.
- Having beneficiaries simplifies the settling of your estate and can reduce the potential for stressful situations for those you leave behind.
- Beneficiaries designated for financial accounts, such as an insurance policy or retirement account, aren’t affected by changes to a will. These direct designations take precedence.
- The names of beneficiaries in financial account documents remain private. A will becomes public record and can expose heirs to public scrutiny.
Types of Beneficiaries
Primary
The primary beneficiary is the first choice of beneficiary made by a financial account owner. While other beneficiaries also may be listed in account or estate documents, this person or organization will receive all of the assets in the account.
Contingent
A contingent beneficiary is a secondary beneficiary. They receive the account benefits only if the primary beneficiary is no longer living or cannot be located. You can name more than one contingent beneficiary and specify how the assets would be divided between them.
How to Choose a Beneficiary
Beneficiaries can be designated for all of your important assets, including property, insurance policies, retirement accounts, brokerage accounts, bank accounts, and more.
When selecting your beneficiaries:
- Assess the relationships you have with family members and who may need your financial help. You may want to consider family pets who may need your protection.
- Review people outside of the family whom you’d like to care for or reward for loyal service through the years.
- Look at organizations that you’ve supported over time and whether they can use your financial support.
Designation Process
Upon first opening your financial accounts, companies ask that you provide beneficiary information. If you don’t provide it at that time, you can request the paperwork at a later date.
Fill it out, sign and date it, and return it to the company. You may be able to complete this process online (check with your financial institution). Maintain a copy of this information for your files.
Tip
Minor children can’t directly receive the proceeds of a life insurance policy, but you could name a trust or your children’s legal guardian as a beneficiary.
Examples of Beneficiaries
Individual Retirement Account
An individual retirement account (IRA) gives the account holder the ability to designate a beneficiary or beneficiaries.
The options for distribution of the assets are different depending on whether the beneficiary is an eligible designated beneficiary or a designated beneficiary.
Each beneficiary type may take a lump-sum distribution of the proceeds, if desired. If not, the choices are as follows.
Eligible Designated Beneficiary
An eligible designated beneficiary is a spouse, the minor child of the account owner, someone less than 10 years younger than the account owner (e.g., a family member or friend), or someone who is chronically ill or disabled.
- A spouse (but no other eligible designated beneficiary) can transfer the assets of the IRA to their own IRA.
- Spouses and all other eligible designated beneficiaries can open an inherited IRA account for the assets they receive. Then, they must take distributions over time, as determined by their life expectancy. The money they withdraw is taxable. Specific distribution rules apply to when they must start to take distributions, so be sure to do your research or discuss this with a financial advisor.
Designated Beneficiary
A designated beneficiary is someone who is listed in the account records as a beneficiary but who doesn’t fit into the category of an eligible designated beneficiary. For example, an adult child could be a designated beneficiary.
- A designated beneficiary can open an inherited IRA account for the assets. They can access any amount of the money at any time, but all of it must be withdrawn within 10 years (the money withdrawn is taxable). In addition, for those who inherited their IRA from someone who had begun taking required minimum distributions (RMDs) before they died, an RMD must be taken every year during that 10-year period. If one isn’t, a 25% penalty could apply.
- The stretch option that allowed beneficiaries to take distributions over their lifetimes is not available if the account holder died on or after Jan. 1, 2020.
If the beneficiary is either an estate or a trust (referred to as a non-designated beneficiary), the executor or trustee directs the distribution of assets. They may open an inherited IRA account and distribute assets according to the rules for a non-designated beneficiary.
Important
If you have an inherited IRA account, be aware that the IRS announced its long-awaited ruling in mid-2024 that certain designated beneficiaries must withdraw (as also described above) at least the RMD for every year of the 10-year withdrawal period. You must use the life expectancy factor to determine this RMD. Your financial institution might figure this out for you.
Not all relevant IRS documentation has been updated yet to reflect this information, and thus can be confusing.
Life Insurance Policy
Life insurance proceeds are tax-free for the beneficiary and are not reported as gross income. However, any interest received or accrued is taxable.
Life insurance beneficiaries can be individuals, such as a spouse or an adult child, or entities, such as a trust. For example, if you have minor children, you may choose to establish a trust and name it as the beneficiary of your life insurance policy.
If you were to pass away, then the policy’s death benefit would be paid to the trust. The trustee would then manage those assets according to the terms of the trust on behalf of its beneficiaries (i.e., your minor children).
Revocable Beneficiary vs. Irrevocable Beneficiary
Life insurance beneficiaries can be revocable or irrevocable. Revocable beneficiaries can be changed if necessary at any time during the policy owner’s lifetime. This is similar to a revocable living trust, which can also be changed as long as the trust grantor is still living.
An irrevocable beneficiary is permanent. If there are multiple beneficiaries named to a life insurance policy (e.g., a primary beneficiary and several contingent beneficiaries), then they would all need to consent to any changes involving an irrevocable beneficiary. Therefore, it’s important to choose beneficiaries carefully.
What Is Meant by Beneficiary?
A beneficiary is a person or organization that has been named to receive property belonging to another person in the event of their death.
What Happens If I Don’t Choose a Beneficiary?
If you don’t choose one or more beneficiaries for your assets, then the decision about what happens to your money will be made by someone other than you, such as a court in the state in which you live.
How Difficult Is It to Designate a Beneficiary?
It’s not difficult at all, once you’ve decided on who your beneficiary or beneficiaries should be. Designating beneficiaries for your financial accounts involves providing the names, Social Security numbers, and other specifics on a form when you open your account. If your accounts have already been opened, simply request the appropriate form for designating beneficiaries, fill it out, and return it to your financial institution. Keep a copy for your files.
Who Can Change the Beneficiary on a Life Insurance Policy?
In the case of a life insurance policy that has one or more revocable beneficiaries, the owner of the policy can change the beneficiary designations at any time. This is something that may be necessary if a beneficiary passes away or if the primary beneficiary is a spouse and the marriage ends in divorce.
If irrevocable beneficiaries are named to a life insurance policy, then the policy owner would need the consent of the beneficiary and any contingent beneficiaries to make a change. For that reason, it’s important to think carefully when choosing policy beneficiaries.
The Bottom Line
Designating beneficiaries is a very important part of estate planning. If you care about the disposition of your financial assets after you’re gone, then choosing beneficiaries for your financial accounts should be a priority.
By designating beneficiaries, you can ensure that your property winds up in the right hands.
