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Trends & Developments - October 2013 - Employee Benefits Update - Retirement Plan Beneficiary Designations: So You Think You're Divorced? Think Again

Nothing can create animosity between parties like a good divorce.  But, how would you feel knowing that your ex-spouse will get all your retirement plan benefits (401 k, 403 b, pensions, etc.) after your death?  If this question is a little disconcerting, please read further.

Background

A beneficiary designation form is a legal document that individuals routinely complete for life insurance policies, retirement plans, and, in some cases, bank investment accounts.  Unfortunately, after the initial designation of a beneficiary, this legal designation of who will receive the assets after the account owner's death is largely forgotten absent some outside impetus (from estate lawyers, accountants, financial planners).  Forgetting to review your beneficiary designations can have extremely negative consequences for your intended heirs after you die. (This also applies to legally married same-sex couples recognized by U.S. Treasury for tax purposes.)

Retirement Plans

Under the Employee Retirement Income Security Act of 1974 (ERISA), the spouse of a legally married retirement plan participant (see IRS Revenue Ruling 2103-17 regarding who is a spouse for this purpose) is automatically entitled to all benefits under the plan unless the spouse has consented, in writing, to the designation of an alternative beneficiary.  The spouse's signature of the consent must be witnessed by the plan administrator or a notary public.  Problems, however, can arise when you divorce, separate, or remarry after a divorce.  Here are some possible consequences assuming your former spouse is named as your beneficiary and you fail to name a new beneficiary after a life-changing event:

  1. Divorce without remarrying – You have a divorce decree and you even had a qualified domestic relations order (QDRO) approved by the retirement plan administrator to spell out what your former spouse is entitled to from the plan, but you never changed your beneficiary designation before you died.  The law is settled in this situation by a Supreme Court ruling (Kennedy v. Dupont Jan. 26, 2009) that concluded that a QDRO is the mechanism by which the former spouse establishes the right to receive all or a portion of the participant's benefit under a retirement plan, but it does not provide a means for the spouse to waive their benefit under the plan.  The court also concluded that the benefits should be paid in accordance with the plan documents and that the plan administrator need only look to the participant's beneficiary designation to determine to whom the benefits should be paid upon the participant's death.  In the Kennedy case, the participant had been divorced for seven years prior to his death, but never changed his beneficiary designation, so the plan administrator paid the $400,000 benefit under the plan to his former spouse.  It is important to note that the Supreme Court decision did not preclude the deceased's estate from suing the former spouse for the benefits received from the plan based on the contractual agreement under either the divorce decree or the QDRO.  The ruling was only concerned with the proper payment of benefits from the plan to the named beneficiary.
     
  2. Separated without divorcing – This assumes that you do not have a divorce decree or a court decree of separate maintenance (a legal separation the details of which are beyond the scope of this article), but are living apart from your spouse with or without a separation agreement drafted by your attorneys, which merely defines the rules of engagement for your living apart.  In this case, ERISA provides that your spouse is entitled to all benefits under the plan upon your death unless your spouse waives those benefits in writing as discussed above.
     
  3. Divorced and remarried – If you are forgetful, the law protects your new spouse and prevents your former spouse from getting your retirement plan benefits if you die.  Since ERISA provides that your surviving spouse is entitled to all your benefits under the retirement plan unless the spouse otherwise waive them, then your current spouse will receive the benefits even if you fail to change your beneficiary designation.  

Individual Retirement Accounts (IRAs)

ERISA does not apply to IRAs.  Accordingly, you can name a beneficiary other than your spouse without their consent.  It is important to consult with both your estate planning attorney and tax advisor when designating IRA beneficiaries (assuming the amounts involved are significant to your estate) as there are many estate planning tools involving IRAs which can save significant taxes.

Conclusion

A retirement plan beneficiary designations is an extremely important legal and plan document that should be reviewed annually by a plan participant.  For plan sponsors and administrators a best practice would be to send an annual reminder to all participants (active, terminated, retired) to review their beneficiary designations to be sure they reflect their wishes if they were to die.


Trends & Developments - October 2013

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