Despite having an up-to-date will, you may not have selected the best way to pass on retirement account assets to your heirs. According to a recent study, most Americans believe their retirement accounts will be divided according to instructions in their wills. In fact, retirement accounts pass according to the beneficiary designations on file with the account custodian.

One common mistake is naming an estate as beneficiary. This error can be committed directly or indirectly since in the absence of a specific designation the estate is the assumed beneficiary. When an estate is named beneficiary of an IRA, all assets in the IRA must be withdrawn within five years of the account owner’s death. This can result in increased taxes and the loss of significant tax-deferred growth potential.  Additionally, when an IRA passes to the estate, beneficiaries named in the will won’t receive their share until probate (sometimes a lengthy process) is complete.

Designating a spouse as beneficiary allows him/her to assume immediate ownership of their deceased spouse’s IRA. This preserves all the benefits of tax deferral enjoyed by the original account owner and provides the beneficiary the most control over when withdrawals are taken and taxes become due. Designated non-spouse beneficiaries are also permitted to enjoy some of the original tax-deferral benefits by establishing inherited IRAs.  Inherited IRAs are subject to annual required minimum distributions, but beneficiaries are effectively allowed to “stretch” withdrawals and taxes over their lifetimes.

Regularly reviewing beneficiaries on all accounts which keep designations on file is your first line of defense. All designations should be consistent with the estate planning put in place with the help of an attorney. Life-changing events, such as marriage, divorce, or the loss of a loved one, should warrant a review of beneficiary designations. Due to legal inconsistencies when compared to married couples, registered domestic partners should consult an attorney to ensure their accounts pass according to their wishes.