What Does It Mean To Make A Beneficiary Designation?
Simply put, a beneficiary designation is the act of naming someone to receive money, property, investments, or any other specific “benefit” (hence, “beneficiary”… get it?)
There are many types of beneficiary designations a person can make. You can name beneficiaries in your Will, on a life insurance policy, and on a registered investment account (like an RRSP). We’ll dig into them here.
Keep reading to find out:
Beneficiary designation meaning
The types of beneficiary designations you can make throughout your life
How to designate a beneficiary
The difference between primary and contingent beneficiaries
Tax considerations for beneficiary designations
Top mistakes to avoid when naming a beneficiary
What happens when you don’t name a beneficiary
Want to know the basics behind naming beneficiaries in your Will? Check out our Beneficiaries page in the Learn Centre.
Types of beneficiary designations
There are many different types of beneficiary designations you can make. And the way you actually do it changes based on what you’re naming the beneficiary for.
A commonplace to name a beneficiary is in your Will. A beneficiary named in your Will is a person or charity who inherits all or part of your estate after you die. You can list one beneficiary to receive all your assets, or you can designate multiple beneficiaries who will inherit various assets from your estate.
Here, you will set out who you want to receive your stuff (money, property and other assets) after you’re gone. This can be very general: “I want to leave ½ of my estate to my son, Joe.” Or it can be very specific: “I want to leave my record collection to my sister, Nancy.” Note: this is not the way it will be worded in your Will.
Life insurance death benefits
Another common place to list a beneficiary is on a life insurance policy. In fact, it’s pretty much the reason you get a life insurance policy – to direct that money be paid out to a specific person, or group of people, when you’re gone.
A “death benefit” is the payout to the beneficiary of a life insurance policy. Beneficiaries usually receive their death benefit in the form of a lump-sum payment from the insurance company. You could also choose to name your estate as the beneficiary of a life insurance policy. In other words, the money gets paid to your estate and is then distributed according to your wishes in your Will.
Registered investment plans
In Canada, there are several types of registered investment accounts (like your RRSP or TFSA). There are tax benefits to having money in these accounts, and they function a little differently than your basic investment accounts. With these accounts, you can designate a beneficiary to receive the money after you die. Generally, most people name beneficiaries on these accounts at the time they create them. If this didn’t happen you should speak with the institution where the account is kept and make sure this gets taken care of.
How to designate beneficiaries
For life insurance policies and retirement plans, you’ll see an option to designate beneficiaries as part of the policy contract or financial plan document. Just complete the beneficiary designation form provided by the insurance company or financial institution.
For estate planning, naming beneficiaries is a standard part of the process of creating a Will. You’ll just need to make sure you use the proper legal names of individuals and charities. With charities, it is wise to also include the charitable number assigned by Canada Revenue Agency.
It is possible to use your Will to designate beneficiaries of a life insurance policy or registered plan. But be careful. It can potentially create some issues in administering your estate if the beneficiaries don’t match with what the institution has on file. There are rules about which designation applies, but it is best to make sure that if you do name a beneficiary in your Will for one of these policies/accounts, that it is the same as the person you gave to the institution.
Primary vs. contingent beneficiaries
Unfortunately, not all beneficiaries are created equal.
A “primary beneficiary” is someone who is first in line to receive your assets.
A “contingent beneficiary” is next in line.
In your Will, you could have a single primary beneficiary and contingent beneficiary. You could also have five primary beneficiaries and five contingent beneficiaries. Or pretty much anything else.
For example, in a simple Will, Kara might name her wife Jane to be a primary beneficiary to receive all of her assets. Kara could also specify that if Jane is not alive on the date of her death, her daughter Susan should receive all of her assets. In this case, Jane is the primary beneficiary and Susan is the contingent beneficiary.
But, it could also be a lot more complicated than that.
Let’s say Kara decided that she wants her wife Jane to receive half of her assets, and also wants to split the other half equally between her five brothers (⅕ for each of them). For each brother, Kara could name a contingent beneficiary.
So, Kara’s Will would say that if Jane predeceases her, her daughter Susan is the contingent beneficiary (entitling her to half of the estate). If any of Kara’s brothers predeceased her, the amount that would have gone to that brother should instead be split equally among that brother’s children.
In this case, we have six primary beneficiaries (Jane and the five brothers) and, depending on how many children there are between all of Kara’s brothers, many, many contingent beneficiaries.
Tax considerations for beneficiary designations
After you die, your Will will likely be submitted to the court to go through the probate process. This is where the court will confirm the validity of your Will and authorize your executor to start acting as your executor. As part of the probate process, your estate is “taxed”, (well, charged a fee).
This is getting a little technical, but some of your property can live “outside your estate”. Generally, assets that have beneficiaries designated (like insurance policies and registered investments), are the kinds of assets that fall outside your estate. This means the probate fee will not be charged and your beneficiary will receive the benefit directly from the institution, not the executor.
It is possible, in some circumstances, for those assets to become part of your estate. For example, if you don’t name a beneficiary at all, or you list your estate as the beneficiary, then the assets will become part of your estate before being distributed.
When this happens, these assets will be subject to probate fees. As a result, your beneficiaries could receive a lower sum than if you had named them as beneficiaries under the policy.
With an RRSP, there are certain tax consequences on your death. Essentially, your RRSP’s value is included as part of your income for the year you died.
Tax on this income may be deferred if the beneficiary is your spouse or common-law partner, a child or grandchild under 18 who is financially dependent on you, or a child or grandchild of any age who is financially dependent on you due to a disability.
Top 4 mistakes to avoid when it comes to naming beneficiaries
Here are some of the most common mistakes you can avoid to ensure your beneficiary designations are clear as day for the people you leave behind.
1. You don’t name any beneficiaries, anywhere.
If you don’t create a Will the laws in your province will dictate who gets all of your stuff. More often than not, it’s not the exact distribution that you would choose. In addition, life insurance proceeds and the money in your registered accounts will be distributed according to the same scheme.
2. You haven’t considered tax consequences.
If you name a beneficiary, your life insurance policy’s death benefit passes “outside your estate”. But if you don’t name a beneficiary as part of your actual policy that benefit will form part of your estate, which means it will be subject to tax when it didn’t need to.
3. You forgot to update your Will or other beneficiary forms.
We know this isn’t fun, but when you undergo a major life change such as a divorce, don’t forget to update your designated beneficiaries … everywhere. Otherwise, your ex-spouse could inherit some of your assets.
4. You name only one beneficiary.
It’s okay to name one beneficiary, but it’s not okay if they die before you. If you’re going to leave all your assets to one primary beneficiary, make sure to also name a contingent beneficiary so your assets are guaranteed to be received by a loved one.
Things you can’t leave to beneficiaries in your Will
Now that you know how beneficiary designations work, here are some things to consider in terms of how they DO NOT work:
Life insurance policies:
Your insurance policy should already list one or more beneficiaries. When you die, your insurance payout automatically goes to the beneficiaries listed in your insurance policy—without any direction from your Will.
Pension plan policies:
As with life insurance policies, pension plan policies also typically already have beneficiaries named.
Certain jointly owned property
: If you are a joint tenant of any asset (like real estate property, or a bank account) your co-owner automatically gets 100% of the asset when you die. This is called the right of survivorship.
Gifts for pets:
Pets can’t legally own anything and therefore cannot be named as a beneficiary. If you want to leave things or money to your pet, leave them to the person you named in your Will to take care of them.