Who You Should Never Name as a Beneficiary

We are asked to provide a beneficiary, and even a contingent (secondary) beneficiary, for our life insurance, retirement accounts, brokerage and bank accounts, and more. In some cases the law requires certain beneficiaries be named. And then we think, Is there anyone I should not name as a beneficiary? The answer is a solid yes.

Your beneficiary designation is an important consideration. You want your assets to go to the people you want when you die. Incorrect designations can prevent people you care about from receiving part or all of your legacy. Worse, no named beneficiary can send your assets to your estate where the law and courts determines who gets the legacy.

Never Name Your Estate as Beneficiary

You want to avoid naming your estate as beneficiary if you can help it. It is the easy choice if you don’t have a preference over who gets your money when you are gone. However, there is significant downside when the estate is the named beneficiary.

Your estate will subject to probate, even if the will has a designated beneficiary. That means:

1. The payout to beneficiaries will be slower while the probate court works through the estate.
2. Your estate is public, whereas monies and other assets with properly designated beneficiaries are distributed to the beneficiaries without public disclosure.
3. Outstanding debts can face claims from creditors. This also slows distribution of funds and can reduce the amount of your legacy beneficiaries receive. Creditor claim protection is a serious reason for not naming your estate as beneficiary.
4. Disgruntled heirs can challenge your will. Wills are often easier to contest since the information is public. Anyone interested in a piece of the pie can petition the court. If the court finds the claim legitimate, some or all of your estate can end up with someone you may prefer did not benefit from your life’s work.
5. Estate administrative costs often increase with the size of the estate. These higher costs can be avoided with properly designated beneficiaries instead of the estate.
6. Focusing now on traditional retirement accounts: Under the SECURE ACT 2.0, a beneficiary that is an individual can use the 10-year rule for distributions. By spreading out the distributions over 10 years, there is a better chance of taxes being lower over all years involved.
7. Estates use the 5-year rule. The higher required distributions affect each taxpayer differently. It can increase taxes on Social Security benefits for older people and their Medicare insurance premium (IRMAA). Younger people may face a higher tax bracket for some of the additional income.

State law governs estates. Rules between states can vary. The rules listed above involve taxes at the federal level and rules consistent among most states.

Alternative to naming your estate as beneficiary: List individuals (family members or friends) or a charity. You can also name a non-family individual as well. Example: You know someone in your community with great need. You can list this individual as a beneficiary for some or all of your legacy. You can also name a revocable living trust. Doing so allows you control over how your assets are managed and disbursed, plus you avoid probate.

Never Name Minor Children as Beneficiaries

Naming minor children as beneficiaries creates issues.

Naming a minor as beneficiary destroys your ability to set any rules on how the children receive the monies.

State law can limit how much a child receives. An appointed custodian may manage the funds in a manner you do not approve prior to the child receiving the assets..

Court intervention and mismanagement are the primary concerns here. There are no do-overs. If the money is lost, your children will not get the funds when they should and as you wish.

Alternatives: You can fund custodial accounts (Uniform Gift to Minors Act (UGMA) or Uniform Transfer to Minors Act (UTMA)). You can also name an adult to manage and invest the assets after you die. However, the assets must be distributed to the minor once she reaches the age of majority.

A better alternative is to set up a trust. You select the management of the assets and how they are distributed. Distribution is not required at the age of majority. As an example, you can spread the distributions over 15 years, from age 35 to 50. This allows your children to mature financially and to prevent one financial decision early on to harm the entire legacy.

Special Needs Children

Special needs children require extra care when estate planning. Management of your legacy for these children will be long-term. Special needs children often receive Supplemental Security Income (SSI) and Medicaid until they qualify for Medicare. Inherited assets can disqualify the child for these benefits. Assets inside a Supplemental Needs Trust is excluded from the child’s assets, allowing for the continuation of medical coverage and supplemental income.

Never Name Your Pets as a Beneficiary

Animals cannot receive your assets because they can’t legally own property. Instead, consider a pet trust, where you decide how your pets are cared for. You provide the trust the resources necessary to carry out your wishes on how you want your pets treated should you become disabled or die.

Other Bad Beneficiary Choices

Updating your estate plan is required to maintain preferred beneficiaries and to support people you care about most in life after you die. A family member or friend can die or move away. Updating your named beneficiaries assures you wishes are always current and known.

While not wrong, the two following beneficiaries are usually a poor choice:

1. Former spouse: Unless the divorce decree requires a former spouse be the beneficiary, it is usually best to steer clear of this landmine. If the relationship remains cordial you may want some of your assets to go to a former spouse. Always consider the family issues that can arise after you die. The former spouse has less incentive to work with your family.
2. Estranged relatives: Estranged relatives can also add unwanted drama to your family after you depart. Think long and hard before bringing this upon your family after you pass.

Avoid Unidentifiable Beneficiaries

While it is not wrong to name “all my surviving children” as primary beneficiaries, if one of your children precede you in death it brings into question where that child’s portion of the legacy goes. Does the child’s beneficiaries get the assets? Or the remaining living children? It appears as if the surviving children get the assets and not the beneficiaries of the deceased child. You can attach a per stirpes clause if you want the deceased child’s beneficiaries to receive the assets instead.

Treasury Regulation §1.401(a)(9)-4 for final required minimum distributions (RMD) states: “A designated beneficiary need not be specified by name in the plan…in order to be a designated beneficiary so long as the individual who is to be the beneficiary is identifiable under the plan.” “All my surviving children” satisfies this requirement.

However, it is best to always name beneficiaries by name, if they are primary or contingent, and what percentage they will receive.

Contingent Beneficiaries

There are primary and contingent beneficiaries. If the primary beneficiaries precede you in death, the contingent beneficiaries become the primary.

If the primary beneficiaries are all deceased and no contingent beneficiary is named, the estate becomes the default.

As discussed above, your estate in not the best choice as beneficiary. Best to have contingent beneficiaries named. You can name more than one primary and more than one contingent beneficiary. There is no reason for the estate to receive assets by default.

Community Property States

The rules are a bit different in community property states. In community property states you are required to leave your spouse 50% of your estate. If you don’t name your spouse, 50% will automatically go to the spouse anyway.

FAQs

What is a beneficiary? The beneficiary is the person or entity who receives your assets after you die.

Can you name a charity as a beneficiary? Yes.

Can a trustee be a beneficiary? Yes

Can a minor be a beneficiary? Yes, but see the discussion above. It is often best to have a trust as a beneficiary for handling the assets for the minor.

How do I choose a beneficiary? You should name a primary and contingent (backup) beneficiary. You can choose any individual or entity. You are not limited to one primary or contingent beneficiary. In fact, it is best to name more than one beneficiary.

Pets cannot be named beneficiaries.

Who should not be named beneficiary?

1. Your estate. There are better choices.
2. Former spouse. Opens the door to drama when you die.
3. Estranged relatives. Same as above.
4. Pets. Animals cannot own property. Instead, consider a trust.
5. Minor children. A trust allows you more detailed management of your wishes.
6. Special needs children or adults. Protect your children while you provide for them with a Supplemental Needs Trust.
7. Chronically ill individuals. They may not outlive you so if you do name a chronically ill beneficiary, be sure to have adequate contingencies.

Who is the best person to name as a beneficiary? In community property states your spouse gets 50% of your estate. Regardless, a spouse or children are the obvious choice. If you have no family or friends you wish to leave your legacy, consider naming a charity. By naming a beneficiary you avoid probate costs and delays in distribution. In the end, the best choice is the one you make.

What are the disadvantages of naming your estate as a beneficiary? See discussion above.

What happens if I don’t designate a beneficiary? Your assets will go to your estate where the court will determine their distribution.

Who cannot be designated as a beneficiary? Pets. Deceased people. Only individuals and entities can be beneficiaries.