Naming Beneficiaries 101
Among the myriad of decisions that investors face, one of the most crucial yet often overlooked is the designation of beneficiaries on investment accounts. This decision not only ensures that your assets are transferred according to your wishes but also can prevent unnecessary legal complications and emotional distress for your loved ones after your passing. Let’s delve into why naming beneficiaries is so important and explain the differences between pro rata and per stirpes distributions, two options you might encounter in the process.
Why Naming Beneficiaries is Critical
Bypassing Probate: One of the primary benefits of naming beneficiaries directly on accounts such as IRAs, 401(k)s, and life insurance policies is that these assets bypass the probate process. Probate can be time-consuming, costly, and public. By naming beneficiaries, you ensure that these assets transfer directly to your loved ones, swiftly and privately[RB1] .
In California, there is a set fee schedule for probate compensation based on the size of the estate. For example, a $1,000,000 estate will have a minimum of $23,000 in fees to a probate attorney. If the family cannot appoint an executor willing to waive compensation (a family member could be executor if there is no contention of the estate), that cost will be double. This amount doesn’t consider any other “extraordinary fees” that may arise from the court. Any estate over $184,500 (California probate minimum) with no beneficiaries listed or titled property would be subject to probate under California law.
Clarifying Your Intentions: In the absence of a named beneficiary, your investment accounts will be distributed according to the default rules of the account custodian or the laws of your state. This might not align with your personal wishes or the needs of your family members. Naming beneficiaries ensures that your assets go exactly where you want them to.
Avoiding Family Disputes: Clearly designated beneficiaries can help avoid disputes among family members, which can be particularly contentious and painful during a time of grief. It's an act of care to leave behind unambiguous instructions.
Pro Rata vs. Per Stirpes
When naming beneficiaries, you might be faced with choosing between pro rata and per stirpes distributions. These Latin terms determine how your assets are divided if one or more of your beneficiaries predecease you.
Pro Rata: Pro rata is the default option in many accounts if no specific designation is made. Under pro rata (meaning "in proportion"), if a beneficiary predeceases you, their share is redistributed among the surviving beneficiaries in proportion to their named shares. For example, if you have three beneficiaries each supposed to receive a third, and one predeceases you, the remaining two would each inherit half of the assets.
Per Stirpes: Per stirpes (meaning "by branch") offers a way to ensure that if a beneficiary predeceases you, their share will pass to their heirs rather than being redistributed among the surviving named beneficiaries. Using the previous example, if one of your three beneficiaries had two children and predeceased you, those children would split their parent's third, receiving one-sixth each, while the other beneficiaries would still receive their intended third.
Making the Right Choice
Deciding between pro rata and per stirpes depends on your family dynamics and how you envision your legacy. Per stirpes is often preferred for those who wish to keep assets within a family line, particularly if they have children or grandchildren they wish to benefit indirectly. However, it's crucial to clearly understand the implications of each choice and consider them in the context of your overall estate plan.
Final Thoughts
As investors, we often focus on the numbers, aiming to maximize returns and minimize taxes. Yet, the importance of naming beneficiaries and understanding the impact of that choice on our legacy cannot be overstated. It's a fundamental aspect of financial planning that ensures our hard-earned assets are passed on according to our wishes, providing peace of mind to us and those we care about most.
At KWB, we can help clarify these options and ensure that your investment accounts are fully aligned with your broader estate plan. Remember, your legacy is not just about the assets you leave behind but about the clarity and care with which you pass them on.
~ Steve Gormley
This information is not intended to be a substitute for specific individualized tax or legal advice. We suggest that you discuss your specific situation with a qualified tax or legal advisor.