Beneficiary

A beneficiary is any person who gains an advantage and/or profits from something. In the financial world, a beneficiary typically refers to someone who is eligible to receive distributions from a trust, will or life insurance policy. Beneficiaries are either named specifically in these documents or have met the stipulations that make them eligible for whatever distribution is specified.

Typically, any person or entity can be named a beneficiary of a trust, will or life insurance policy, and the one distributing the funds, or the benefactor , can put various stipulations on the disbursement of funds, such as the beneficiary attaining a certain age or being married. There can also be tax consequences to the beneficiary. For example, while the principal of most life insurance policies is not taxed, the accrued interest might be taxed.

Qualified retirement plans, like a 401(k) or IRA, give the ability of the account holder to designate a beneficiary. Upon the qualified plan holder’s passing, a spousal beneficiary may be able to roll the proceeds into his own IRA. If the beneficiary is a not the spouse, there are three different options for distribution. The first is to take a lump-sum distribution, which makes the entire amount taxable at the beneficiary’s ordinary income level. The second is to establish an inherited IRA and withdraw an annual amount based on the life expectancy of the beneficiary, also known as a stretch IRA. The third option is to withdraw the funds at any time within five years of the original account owner’s date of death.

In the event the beneficiary is either an estate or a trust, the distribution rules are more limited. The stretch option is no longer available and only the lump-sum and five-year rule options are available. Any proceeds left to the estate also make it subject to probate.

A spousal beneficiary of a Roth IRA is also allowed to roll over the inherited proceeds into his own Roth IRA. For a non-spousal beneficiary, the distribution options mirror the same as inheriting a traditional IRA. The only difference is Roth IRA distributions are not subject to taxation.

Life insurance proceeds are considered tax-free to the beneficiary and are not reported as gross income. However, any interest received or accrued is considered taxable and is reported like any other interest received.

Nonqualified annuities are considered tax-deferred investment vehicles that allow the owners to designate a beneficiary. Upon the death of the owner, the beneficiary may be liable for any taxes on the death benefit. Unlike life insurance, annuity death benefits are taxed as ordinary income on any gains above the original investment amount. For example, if the original account owner purchased an annuity for $100,000 and then passed away when the value was worth $150,000, the gain of $50,000 is taxed as ordinary income to the beneficiary.