The financial field is full of professional terms. Some of them do not cause questions, because they are used in everyday communication. Others are used so rarely that they become new words to most people.
A beneficiary is any person, who gets a benefit and/or profit from any action or transaction. The term "beneficiary" is often used exactly as the economic dictionary gives it - it is a recipient who is allowed to receive distributions from a trust fund, will, or life insurance policy. Beneficiaries are usually listed on these documents or have satisfied conditions that make them eligible to get a certain benefit.
The concept of a Beneficiary
Generally, any person or entity can be a beneficiary of a fund, will, or life insurance policy. The sponsor giving the funds may impose a variety of conditions on the distribution, such as the reaching a certain age of the beneficiary or getting married. In addition, there may be tax consequences for the beneficiary. For example, while the principal amount of most life insurance policies is not taxable, the resulting interest may be taxable.
One of the most important things to solve after retirement or earlier, is the distribution of assets into the right hands. If you or your spouse do not list beneficiaries, your estate is not distributed to selected beneficiaries, but according to the inheritance laws of the state.
Types of Beneficiaries
A beneficiary can be either an individual or a legal entity. Also, they are divided by the level of influence they have in the company. Some of them are unconditional owners, while others have some limitations. Here is a brief look at some types of beneficiaries:
- recipients of income from bank and brokerage accounts;
- property owners who take rents;
- individuals, who give funds in trust;
- clients of insurance companies;
- company owners and large investors.
In other words, each final recipient of profit is a beneficiary. In investment, each stockholder owning an appropriate block of securities can be considered a beneficiary. It is sufficient to open a brokerage account or IIA (individual investment account) and form an investment portfolio on it.
But the recipient and the beneficial owner are different concepts. While the first one receives regular or one-time payments, the second one owns a significant share of the company and/or influences everything that happens there.
Sometimes such concepts as funder and beneficiary are confused. In most cases, they are the same, but if one of the funders has less than 25% of the company and his vote is not the deciding one, then the concept of "beneficiary" refers to him only as a profiteer, not as the owner.
Beneficiary and qualified accounts
There are four options for qualified account distribution. The first one is a qualified retirement plan or individual retirement account (IRA), according to which the spouse beneficiary gets the right of fund distribution. The second one is a lump-sum distribution, which demands the tax from the entire amount. This tax should be at the beneficiary’s ordinary income level. The third one is to open a «stretch IRA». This is an inheritable IRA, from which a certain amount can be withdrawn each year, depending on the beneficiary's life expectancy. The fourth option is to withdraw funds at any time within five years of the account holder's date of death.
The Stretch option is not available anymore for 2020 legacies due to the law of the Setting Every Community Up for Retirement Enhancement (SECURE) in 2019. Only lump-sum and the five-year rules will be available in the future. The SECURE Act provides that most non-spouse IRA beneficiaries must receive payments equal to the entire account balance within 10 years. The distribution rules are more restricted, if the beneficiary is an estate or trust. Any income left to inheritance is also subject to a will.
Beneficiary and Life Insurance
Any income earned or accrued from life insurance is considered taxable and counts like any other interest, while life insurance interest is not taxable and is not counted as gross income.
Life insurance beneficiaries can be individuals (spouses or adult children) and legal entities (trusts). You can set up a trust and list it as the beneficiary of your life insurance policy if you have minor children. In case of your death, the insurance benefit will be paid to the trust. The management of assets under the terms of the trust will be delegated to a Trustee on behalf of the beneficiaries (such as your children).