If you've filled out paperwork for life insurance or a retirement account, you've probably come across the terms "primary" and "contingent" beneficiary. But what's the difference between the two concepts, and how do their rights affect the transfer of assets?

First, let's define the word that they both have in common: "beneficiary." A beneficiary is any person, trust, or entity that is designated by the financial account holder to receive some portion of the assets in the account after he or she dies.

Contingent vs. primary beneficiary
A primary beneficiary is simply first in line to receive the assets in the account, while the contingent beneficiary is next in line. There can be multiple primary and contingent beneficiaries, but contingent beneficiaries only receive their benefits in the event that none of the primary beneficiaries survive the account holder.

Here's a simple example.

A man passes away after accumulating $100,000 in a retirement account. He originally named his wife and brother as 50/50 primary beneficiaries but did not make any change to this designation after his brother passed away. The account holder also named his three adult children as contingent beneficiaries. In this instance, the man's wife would be first in line to receive all of the assets because of her status as a primary beneficiary.

Of course, the beneficiary designation process can get much more complicated from here -- by including trusts or by attaching conditions on a beneficiary's status, to name just two examples. But in each case the key distinction remains the same: Primary beneficiaries have first claim on the asset upon the account holder's death.

Why you should name beneficiaries
Even though naming a beneficiary, either primary or contingent, is optional for many retirement and insurance accounts, it's generally recommended that you take the time to do it. Otherwise, your passing might cause unnecessary probate expenses and delays for the heirs you intended to receive your assets.

It also might trigger a costly liquidation process. Many retirement accounts, for example, allow spousal beneficiaries to transfer an IRA into their own name and therefore delay required distributions until after age 70. Non-spousal beneficiaries, by contrast, are often required to begin taking distributions from the account immediately, which would lower the amount of time the assets can generate tax-differed growth. That's why it's important to be clear about whom you designate as your primary and contingent beneficiaries.

Common issues
According to a recent study by the U.S. Department of Labor, these are the two most common issues that can create disputes among heirs to an estate but are also in the account owner's power to avoid ahead of time:

  • Failing to change beneficiary designations to reflect life events. For example, after a marriage or divorce, many people forget to update their desired beneficiaries accordingly. Failing to do so can result in legal conflicts between current or ex-spouses and other potential beneficiaries.
  • Electing an impermissible beneficiary. A beneficiary must have the legal power to accept the asset that you've assigned to that person upon your death. That means that minor children and pets are won't work. For minors, the money will instead go to a legal guardian until the beneficiary reaches 18 or 21, depending on state law. In general, naming an entity that can't claim your asset will result in delays as the account manager works to establish the next legally appropriate beneficiary.

You can avoid these complications by taking the time to name primary and contingent beneficiaries when you open any financial account, and by periodically reviewing these designations to ensure that they still reflect your current wishes.

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