Account owners want to know what designations are possible and whether or not to have them on their account.  Beneficiaries themselves were more concerned about the disposition of the account if there were no beneficiaries listed or if some beneficiaries pre-deceased the owner.  We will address the basic elements of this topic to help clear up confusion or commonly-held misconceptions about beneficiary designations.  This is not tax or estate planning advice: investors should review their personal situation with their tax or estate planning advisor.

Designating a beneficiary on a mutual fund account can be part of an investor’s overall estate plan.  It helps fulfill the investor’s wishes regarding their assets and can avoid part of the probate process, which is the legal process after someone dies that includes distributing assets to the decedent’s heirs.  Mutual fund accounts and other assets without a beneficiary will likely go through the probate process to determine who will inherit the account or asset.  Costs associated with probate include fees for court filings, personal representatives and attorneys can reach into the thousands of dollars depending on the complexity and size of the estate.  In addition to the cost, there is the possibility that the process of determining who will inherit the assets will not conclude exactly as the decedent intended.  State law governs the succession of the assets, and in the absence of further instruction such as a will, the order is generally spouse, children and then cognate relation.  Cherished friends, in-laws and beloved charities are unlikely to be part of that list.

Some investors write wills or use a common form of property ownership, joint tenants with right of survivorship, as a method to direct an account to another person(s) in the event of their death.  While these measures may ensure that the intended heirs or surviving owner will take control of the account, they do not necessarily avoid probate.  This type of joint ownership avoids probate as long as there is a surviving owner, but if all owners were to pass away and no beneficiary was designated, then the account would flow through the probate process anyway.

Wills are useful in the probate process and may save time and expense as they would likely speed up the process of distributing the assets, but they do not avoid probate.

Creating a living trust is another way to avoid probate and ensure that assets go to the intended heirs.  Many shareholders put their account(s) into a trust and retain control by naming themselves as trustee.  Upon death, a successor trustee will help fulfill the wishes of the person who established the trust (the “grantor”).  Not only will the assets in the trust avoid probate, they can continue to be managed by a successor trustee long after the grantor’s passing.  Although investors may benefit from these and other advantages, they should consult with an attorney to make sure the trust is applicable for their situation and properly structured.

Retirement accounts such as IRAs and 401(k) plans may be administered differently than non-IRA accounts when it comes to beneficiary designations.  Some states require the participant’s spouse to give written authorization before anyone else can be listed as beneficiary.  There may be other provisions as well.  For example, Sit IRA accounts automatically assume the spouse is the beneficiary if there are no other beneficiaries listed or living. Given the possible variations between retirement plans, it may be best to read the custodial or plan document before completing the beneficiary section.

Reviewing beneficiary designations on a periodic basis is just as important as having a beneficiary named at the opening of an account.  Changes occur over time that may require updates, such as removing an ex-spouse, adding children or replacing a deceased beneficiary.  It may also be a good idea to name multiple beneficiaries who can be listed as either “primary” or “secondary”.  Secondary beneficiaries receive assets only if there are no surviving primary beneficiaries.  Sit Mutual Funds accounts allow for a variety of beneficiary designations including primary, secondary and “lineal descendants per stirpes,” which means a deceased beneficiary’s descendants will receive that share of the asset.  Note: the “lineal descendants per stirpes” designation is only available for IRA accounts currently.

Another tax-related issue arises when the owner of a mutual fund non-IRA account passes away.  If the beneficiary is a non-spouse, then the cost basis of those shares is usually adjusted upward to the market value as of the date of death, also known as a “full step up”.  This adjustment effectively eliminates the tax liability for the beneficiary on any previous gains.  Similarly, a surviving spouse will receive a cost basis adjustment to shares as well, but it will typically only be a “half step up” in basis.  For example, if the gain on the asset at the time of death was $100,000, then $50,000 (the “half step”) would be excluded from future taxation.  Overlooking a step up in basis could be a costly mistake, especially if the shares have appreciated significantly in value.

The Sit Funds recordkeeping system automatically calculates these general step ups in basis for beneficiaries in the absence of detailed instructions.  However, caveats exist to the cost basis and valuation process, such as alternate valuation dates, special rules for retirement accounts and varying state laws, so investors should consult with a tax or estate planning attorney to make sure that is the proper adjustment.

Beneficiaries may be changed at any time, but it must be done in writing.  Forms are available for regular accounts or IRA accounts.  Sit Mutual Funds accounts offer flexible beneficiary designations and account ownership options so shareholders can optimize their accounts for their personal situations.  Call an Investor Services Representative at 800-332-5580 to review your beneficiary designations and options.