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How to Choose Beneficiaries: What You Should Know Thumbnail

How to Choose Beneficiaries: What You Should Know


Knowing how to choose beneficiaries is important because sometimes you only get one chance. You'll likely choose life insurance beneficiaries and beneficiaries for any other financial assets, such as brokerage and retirement accounts.

Here's what you must know.

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How to Choose Beneficiaries

Choosing beneficiaries is a big decision and a personal one too. You might get a chance to change your mind down the road, but it's not a decision to take lightly because tomorrow is never promised.

You may choose primary beneficiaries and contingent beneficiaries. This is especially important if you won't change beneficiary designation in the future. The contingent beneficiary will receive the life insurance death benefit if the primary beneficiary isn't alive when you die.

What Is a Beneficiary?

A beneficiary is a person you choose to legally receive your financial accounts and products. Common products requiring beneficiary designations include a life insurance policy, annuities, retirement, and investment accounts.

The person designated as the beneficiary will take possession of the accounts and their proceeds upon your passing. You can choose one primary beneficiary, have multiple beneficiaries if you want to split up your assets.

Who Can Be a Beneficiary?

Almost anyone can be your life insurance beneficiary for your death benefits unless your state laws or provider have restrictions. A beneficiary can be a person, a charity, a trust, or an estate. You can also choose one or more people as the beneficiaries of the same financial accounts.

Who You Should Never Name as Beneficiary

You can name anyone you want as your beneficiary; however, you should avoid naming anyone on government assistance as a direct beneficiary, as the life insurance proceeds may eliminate their government benefits.

It's also a good idea to avoid naming a minor child as a beneficiary as there could be legal issues transferring the life insurance benefits to them. Instead, you can create a trust and name a trustee to manage the money for your children.

Accounts and Taxes

Before naming beneficiaries, it's a good idea to understand the different types of accounts and their tax liabilities to see how your beneficiaries would be affected.

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Taxation of Roth IRA Accounts

Roth IRA contributions are after-tax, so your primary and secondary beneficiaries won't worry about paying taxes on the proceeds. In addition, most Roth IRA accounts allow beneficiaries to have tax-free withdrawals, but some may have requirements regarding how long beneficiaries have to withdraw the funds.

Taxation of IRAs, 401ks, 403B Accounts

Standard retirement accounts without the tax benefits of Roth IRAs work differently. Instead of beneficiaries receiving the accounts tax-free, they'll pay taxes on proceeds when they withdraw them.

However, they have one benefit. Beneficiaries receive investment accounts based on a stepped-up basis. This means the value is on the day you die, not the day you open the account. So if they cashed out the proceeds immediately, they'd limit their tax liability, but even if they leave the funds in the accounts, they'll only pay taxes on the earnings they earned while in possession of the account.

Trusts Accounts

Trust accounts have higher tax rates when the funds sit in the trust, but it's often a better option than distributing all funds to a beneficiary who can't handle them. For example, trust values of $14,451 or higher pay the highest tax rate of 37%. However, you can set up a trust to distribute funds monthly or quarterly to offset the taxable income. Beneficiaries pay taxes on trust income received as regular taxable income.

Property Accounts

Property has the same tax advantages as regularly taxed retirement accounts. Beneficiaries receive the property at a stepped-up basis value or the value on the day you day. If they sell the property immediately, they may keep more funds because there won't be as large of a tax liability.

However, if they hold the property and it appreciates, they'll pay taxes on the capital gains earned from the day you died to the day they sold the property.

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How Tax Affects What Your Beneficiary Receives [Examples]

It may help you understand how taxes affect what your beneficiary receives to help you make decisions by looking at some examples.

IRA Example

Your beneficiaries will pay taxes on IRA funds as they withdraw them. If you have young beneficiaries, they may be in a lower tax bracket if they have lower income. As a result, they can structure the withdrawals to keep their tax liabilities at a minimum.

However, older beneficiaries with higher incomes may be in higher tax brackets and lose more money to taxes.

Roth IRA Example

If the Roth IRA you inherit is from your spouse, it's treated as if it's your own IRA. So you can roll it over into your IRA and not worry about any tax issues.

However, if you receive a Roth IRA from anyone other than your spouse, you must withdraw the funds within ten years. After that, you can stretch out the distributions to allow the earnings to continue compounding to increase the earnings.

Brokerage Example

Any regular brokerage accounts you have to pass down will pass down on a stepped-up basis. Your beneficiary designations will pay taxes at their current tax rate when they withdraw funds or sell the assets.

Property Example

Passing down a home can cause strains between beneficiaries, making it difficult. Some people pass down the home to one beneficiary and the brokerage account to another to avoid disagreements between family members.

Asset Splitting Is a Complicated Game

Asset splitting isn't for the faint of heart. Money can do weird things to people, causing issues among even the closest family members. The key is to evaluate the situation, decide how to minimize the tax liabilities of each beneficiary, and fairly distribute the assets, so each family member feels loved and has their fair share of the assets.

There aren't any laws stating the assets must be divided equally. You can divide assets however you feel you should.

Planning Beneficiary of a Trust

Planning a trust is a whole different playing field. There are simple trusts, but they can get as complicated as you want.

How to Name a Custodian for Minor Beneficiary

Choosing a custodian for a minor child is a big decision. Typically, you choose the legal guardian for the child or someone close to the child you can trust to distribute the funds as you designate in the trust.

Help With Money Management Troubles

You may also have beneficiary designations that have trouble managing money. This is common even in adult children. For example, if there is an addiction problem or an adult child with special needs, you may need someone to oversee the funds left to them. The custodian would be responsible for regular distributions, sometimes even weekly, if the funds are to cover ordinary living expenses.

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Defining Tax-Deferred Accounts

Tax-deferred accounts don't pay taxes as you earn them but when the owner withdraws the funds. This gives the funds more time to compound, and owners strategically plan when to withdraw funds for the best tax outcome.

Inherited Taxed Deferred Account Outcome

Recent rules changed when beneficiaries must withdraw funds from an inherited retirement account. Most people have up to ten years to withdraw the funds and pay the applicable taxes. However, depending on the amount inherited, beneficiaries may also be required to take distributions in the first nine years.

Defining Tax-Exempt Accounts

Tax-exempt accounts, such as Roth IRAs, don't require that beneficiaries pay taxes. Instead, the owner pays taxes before contributing the funds, so they grow tax-free and can be withdrawn tax-free. However, similar to traditional IRAs, beneficiaries may have 5 - 10 years to withdraw the funds.

HSA Accounts

HSAs are the rule to the exception. Only spouses may roll over the funds to their HSA; all others must withdraw the funds within the year of death.

Defining Taxable Accounts

Taxable accounts don't have tax benefits, except the stepped-up basis beneficiaries receive. So everyone pays taxes as they go on taxable accounts. However, there are short-term and long-term capital gains rates.

Short-term capital gains rates are identical to your standard income tax rates, but long-term capital gains rates are lower. So any capital gains you earn on investments you've held for over one year are subject to the lower long-term capital gains taxes.

Beneficiary Who Should Receive Specific Assets

Deciding which assets should go to each beneficiary is a big decision. While it's a personal decision, here are some factors to consider.

Retirement Accounts

Retirement accounts, except for Roth IRA accounts, should go to charity if you plan on giving to charity. The benefit of giving it to charity is they won't pay taxes on the earnings, but your beneficiaries will. If you have other assets you can leave to your loved ones, let the charity have the retirement accounts (except Roth accounts) and let your beneficiaries enjoy more tax benefits.

HSA Accounts

HSAs are best for spouses because they can roll the funds over and not worry about taxes. Anyone else who inherits an HSA will pay taxes on the funds in the year you die, which could leave them with a significant tax liability.

Brokerage Accounts

Brokerage accounts provide more benefits for beneficiaries because of the stepped-up basis. Your loved ones pay taxes only on the earnings made from when you die to when they sell the assets. They have more control over the taxes they'll pay and can strategically plan to minimize liability.

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What Happens to an IRA When Someone Dies?

When someone dies and passes on an IRA, the recipient is subject to the required minimum distributions. In addition, most people must have withdrawn 100% of the funds within ten years of receiving the account.

Do You Have to Have a Beneficiary?

You aren't required to have a beneficiary, but if you don't, the assets will go through probate, leaving anyone you want to have your assets with, much less if anything, after you die. Probate can take months or years, too, tying up your loved ones' funds.

What Happens to My Accounts if I Don't Have a Beneficiary?

If you don't have a beneficiary named, your accounts go through the probate court process, which could take months or years.

What Information and Documents Do I Need to Assign a Beneficiary?

To assign a beneficiary, you must have their full name, Social Security number, date of birth, address, and relationship with you.

Can a Beneficiary Be Changed?

Some assets allow you to change beneficiaries, but it depends on the asset and sponsor. Always ask before designating one to ensure you know if you can make changes. If you're able to change beneficiaries, you will likely complete a beneficiary change form.


Knowing how to choose beneficiaries and keeping your beneficiaries up to date is important. Life changes often, so it's important to know if and how you can change beneficiaries if necessary. Having primary and contingent beneficiaries is also a great way to ensure your financial assets go to the people you intend.