Why Contingent Beneficiaries Matter

Reader Question:  I have named two family members as beneficiaries in equal shares on my portfolio. I was advised to also name contingent beneficiaries. Will you explain what a contingent beneficiary is and what might happen if none are named? Also, I have named a different family member as POD on my savings accounts. Should a contingent beneficiary be designated on them as well?  G.H.

Answer:  A contingent beneficiary (a person, trust or charity) would receive your assets if the primary beneficiary (your first choice) should die before you and you fail to make any changes.  For example, assume you buy a life insurance policy.  It’s common to name your spouse as the primary beneficiary of your life insurance and your child as the contingent beneficiary.  If your spouse predeceased you and you died having not made any changes to your beneficiary designation, your child would automatically receive the life insurance proceeds.  If you had no contingent beneficiary, the proceeds would transfer according to your will.  If you did not have a will, the proceeds would transfer based on the state laws (called intestate) in which you reside.  Your beneficiary designations are very important and should be thought through very carefully since a mistake can have unintended consequences. In this reader’s case, certainly no contingent beneficiary is required as long as she is ok knowing that if one of them predeceases her all of the portfolio will go to the remaining beneficiary. Of course, she can change beneficiaries at any time.

Reader Question regarding my recent column on the Alabama 529 college savings plan:  While I agree the Alabama 529 plan has come a long way and I encourage people to participate, I disagree with your advice concerning rollovers from out-of-state plans to the Alabama plan.  The problem is the gain on the amount rolled over from out-of-state to Alabama is taxable at the time of rollover.  I have confirmed this in years past through the Department of Revenue.  The growth while in the plan will of course be a tax free withdrawal.  One plus is that usually the growth is way below the amount allowed for the (State of Alabama) deduction and the owner does not face a huge tax bite.  But this does reduce the benefit of the deduction.  Your article failed to mention this and the resulting tax liability.

Answer:  Few things in finance are simple and straight-forward and many are complicated.  This is why it’s important to work with experienced financial, tax and legal advisors.  In this case the reader has wrong information.  If you have money in an out-of-state 529 plan and use those funds to pay directly for college expenses, Alabama will require that you pay Alabama taxes on the gains of the money withdrawn.  If, as my article suggested, you first roll over the out-of-state plan money directly into the Alabama 529 plan and then withdraw to pay for qualified education expenses, you will avoid that tax problem and receive a dollar-for-dollar Alabama income tax deduction for up to $10,000 (joint tax filers; single filers limited to $5,000).

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