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Why contingent beneficiaries shouldn't be an afterthought

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One of the most crucial pieces of estate planning is designating the beneficiaries for trusts, life insurance and other accounts that would be passed along at the time of death. For most people, that’s pretty automatic: their spouse is their primary beneficiary and, perhaps, their children are co-beneficiaries.

But the question of a contingent beneficiary — in case the primary beneficiary is deceased or incapacitated — is often made quickly, without a great deal of thought. While this choice may often seem just as obvious as the primary beneficiary, it can actually be a great deal trickier. And the clear choice can very well change over time, giving the proactive financial advisor an opportunity to help his or her clients revisit these important decisions.

See also: 10 steps for avoiding estate planning mistakes

One aspect that many clients do not focus on is that the contingent beneficiaries come into play only when the primary beneficiary is out of the picture. So the only means by which, say, a life insurance policy would go to a child as a secondary beneficiary is if both the client and his or her spouse were deceased. Especially for minor children, that’s a scenario that should not be taken lightly.

Many advisors recommend that a guardian be added to the list of contingent beneficiaries if such a dire situation occurs. It may be better to leave something for the children’s guardian rather than leave all the assets directly to the children themselves, especially for younger kids.

If one child or family member shows distinctly better ability to handle money — or more maturity than the rest of the potential heirs — the client may wish to designate that person as the contingent beneficiary with express directions to take care of siblings or other family members. Or if one of the children is significantly older than the others, perhaps that one should be the sole contingent beneficiary.

That brings up a key reason to revisit those contingent beneficiaries: basic life changes. Someone who provided money for a guardian in the earlier scenario would eventually want to revise his or her beneficiaries to remove the assets allocated to the guardian.

And as those children pass through the various stages of their lives — through college and marriage and careers — your clients may wish to reconsider whether the money they have allocated to each ought to be changed. It’s possible that upon turning 21, the oldest child should become the sole contingent beneficiary. Because these are contingent beneficiaries rather than primary ones, it’s easy for that decision to fall through the cracks.

There’s another reason to be vigilant about who those contingent beneficiaries are: avoiding probate. Assets — such as life insurance policies — that do not have living beneficiaries at the time of the policyholder’s death are generally subject to probate. Not only is probate a major hassle for the people left to deal with it, but the assets the client intended to leave to his or her heirs will be tied up in court and spent on legal fees.

Your clients should be aware that this is not something that can be cleared up in their will. If the contingent beneficiary on their IRA was a favorite niece who has fallen out of favor, the client can’t rectify that error by directing that money elsewhere in his or her will. The beneficiary designation takes precedence over anything declared in the will. (Remember, though, assets that don’t pass through the will are still considered part of the decedent’s estate for tax purposes.)

Finally, your client may wish to discuss these beneficiary arrangements with each of his or her designees. Some of the people they have in mind as contingents may not want to serve in that role; they may prefer the client leave those assets to charity or some other purpose. If there isn’t an obvious choice among family members, the client may wish to talk to close friends about being a contingent beneficiary. Without that contingent in place, remember, assets could end up in probate, and the client could be left with little ability to direct where his or her money goes.

Naming contingent beneficiaries can seem like little more than a nuisance. But it is the kind of decision that costs your clients a half hour now — and could save them an awful lot more in the long run.

For more on estate planning, see:

The clock is ticking on GRATs

How the permanent estate tax will impact life insurance ownership

6 clients who could benefit from a Roth conversion


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