A beneficiary is a person selected by the owner of a particular financial to assume ownership of the asset in the event of the owner’s death. Generally, an account with a named beneficiary pays the death benefit directly to them, bypassing the probate process.
Who Can Be a Beneficiary?
You can name both natural and non-natural persons as a beneficiary.
A natural person is any individual – they don’t have to be a relative. If they’re a minor, the owner may need to designate a custodian for that minor’s benefit in the event that they have not yet reached the age of majority at the time of the owner’s death.
A non-natural person can be a trust, estate or even a business or a charity. It is important that you identify a trustee or other authorized person to act on behalf of the beneficiary during the death claims process.
A beneficiary’s tax responsibility depends on the type of asset they inherit.
Beneficiary of a Life Insurance Policy
The tax treatment of a life insurance death benefit is very straightforward. In the vast majority of instances, the benefit is tax-free to the beneficiary.
Beneficiary of a Qualified Retirement Account
In a qualified retirement planning account such as a traditional individual retirement account (IRA), there may be several options.
If your spouse is your beneficiary, they may be able to roll your IRA into their own IRA with no tax consequence.
If your beneficiary is someone other than your spouse, they will have three options.
The first option is for them to take their benefit as a lump sum. The entire benefit will be taxable at the ordinary income tax rate.
The second option is a stretch IRA. In this scenario, they will establish their own IRA using the money you left them. They then take distributions from this account using a schedule based on their life expectancy. This option is not available if it’s a non-natural person (such as a trust or estate).
If your beneficiary needs some time to decide, their third option is to defer their benefit for up to five years from your date of death.
Beneficiary of a Non-qualified Annuity
Non-qualified annuities are funded with post-tax money that has already been taxed. Gains in an annuity are taxed at the ordinary income rate – whether the owner or the beneficiary realizes them.
For example, if you invested $200,000 in an annuity and it had grown to $300,000 at the time of your death, your beneficiary would pay taxes on the $50,000 in earnings.
Levels of Beneficiaries
When selecting beneficiaries as part of your retirement planning process, it is important to understand a few key terms.
A primary beneficiary is a person (or persons) to whom you want your assets transferred after you die.
A contingent beneficiary is sort of a runner-up. This person receives your death benefit in the event that the primary one is also deceased at the time of your death.
Some companies also allow for the designation of a tertiary beneficiary. They would be next in line if both the primary and contingent ones predecease you.
