Common Misconceptions About Beneficiary Designation

The most common misconception about beneficiary designation is that a will can override the beneficiary designation on a retirement account or life insurance policy.

Misconceptions

• Myth: A will can override the beneficiary designation on a retirement account or life insurance policy.
• Fact: The Employee Retirement Income Security Act (ERISA) dictates that beneficiary designations on retirement accounts, such as 401(k) plans, supersede the instructions in a will, as seen in the case of Egelhoff v. Egelhoff, where the Supreme Court ruled that ERISA preempts state laws that would allow a will to override a beneficiary designation.
• Source of confusion: This myth persists because many people mistakenly believe that a will is the ultimate authority in distributing their assets after death, a notion often perpetuated by media narratives and some estate planning textbooks.
• Myth: Beneficiary designations are only necessary for retirement accounts and life insurance policies.
• Fact: Beneficiary designations are also necessary for annuities, trusts, and other financial instruments, as these designations determine who will receive the assets in these accounts after the owner's death, with approximately 70% of annuity contracts having a named beneficiary (LIMRA).
• Source of confusion: The lack of awareness about the breadth of financial instruments requiring beneficiary designations contributes to this misconception, as many financial advisors and planners may not thoroughly discuss these requirements with their clients.
• Myth: A minor can be named as a beneficiary of a retirement account or life insurance policy.
• Fact: Minors cannot directly receive the proceeds of a retirement account or life insurance policy, as they are not legally competent to manage these assets, and a guardian or trust must be established to manage the assets on their behalf, as outlined in the Uniform Transfers to Minors Act (UTMA).
• Source of confusion: This myth stems from a misunderstanding of the legal requirements surrounding the transfer of assets to minors, often due to a lack of detailed information provided by financial institutions.
• Myth: Beneficiary designations cannot be changed after they are made.
• Fact: Beneficiary designations can typically be changed by the account owner at any time, as long as they are competent to do so, with some plans requiring the consent of the current beneficiary, as noted in the Spousal Consent requirements for certain retirement plans.
• Source of confusion: The complexity of the rules governing changes to beneficiary designations, particularly for retirement plans covered by ERISA, contributes to this misconception.
• Myth: Beneficiary designations are only relevant for tax purposes.
• Fact: Beneficiary designations determine not only the tax implications but also who will receive the assets after the owner's death, with the Secured Futures study finding that 62% of Americans believe that having a beneficiary designation in place is more important than having a will.
• Source of confusion: The emphasis on tax planning in financial discussions often overshadows the more significant impact of beneficiary designations on the distribution of assets.
• Myth: A beneficiary designation must be made at the time an account is opened.
• Fact: While it is advisable to make a beneficiary designation at the time an account is opened, it can be made or changed at any later date, with some financial institutions allowing online updates to beneficiary designations, as offered by Fidelity Investments.
• Source of confusion: The myth likely arises from the common practice of requiring initial beneficiary designations at the account opening, leading people to believe this is the only opportunity to make such a designation.

Quick Reference

• Myth: A will can override beneficiary designations → Fact: ERISA dictates beneficiary designations supersede will instructions
• Myth: Beneficiary designations are only for retirement accounts and life insurance → Fact: Also necessary for annuities, trusts, and other financial instruments
• Myth: Minors can be direct beneficiaries → Fact: Minors require a guardian or trust to manage assets
• Myth: Beneficiary designations are unchangeable → Fact: Can be changed by the account owner at any time, with possible spousal consent requirements
• Myth: Beneficiary designations are only for tax purposes → Fact: Determines both tax implications and asset distribution
• Myth: Beneficiary designations must be made at account opening → Fact: Can be made or changed at any later date