The cases start all over the country and leave a trail of misery and disappointment:
- An ex-spouse receives a retirement account instead of the deceased’s minor children, as intended . . .
- An ex-girlfriend from 30 years ago receives a retirement account instead of the deceased’s family . . .
- A divorce decree states the spouse is to give up her rights to receive retirement benefit proceeds, but the plan participant fails to change the beneficiary designation, depriving the participant’s daughter of the benefits . . .
- A plan participant rolls her qualified plan over to an IRA, and designates her long-time friend as the beneficiary, surprising her spouse when the participant dies . . .
What do all these misfortunes have in common? The Employee Retirement Income Security Act of 1974, commonly known as ERISA, is the culprit. ERISA is a federal law that controls almost all private business retirement plans. The law is supposed to protect the plan participant, usually an employee, and his or her spouse and provide continued family income security. Thus, the law prevents the plan participant from transferring the benefits but allows ex-spouses some access through specialized court orders in a divorce.
Because most beneficiary designations involve spouses, ERISA can create havoc when it overrules state law, which may direct that ex-spouses will not receive any benefits from the plan once the divorce is finalized or, in some states, when the couple is legally separated.
The Supreme Court has weighed in on these rules twice, concluding that ERISA does overrule local law for privately sponsored retirement plans, yet the issue keeps getting litigated.
Problems often arise when a plan participant designates a beneficiary and never updates it.
- Because David Egelhoff did not change the beneficiary designation of his Boeing pension plan, his ex-wife received his benefits instead of his minor children from a previous marriage.
- Because Jeffrey Rolison designated his girlfriend as the beneficiary of his retirement account 28 years before his death and did not change it, Peggy Losinger, the former girlfriend, received over $750,000 in retirement benefits in place of Jeffrey’s spouse.
- Because William Kennedy did not change his beneficiary designation after his divorce, his ex-wife, Liv, received the benefits from his retirement plan instead of his daughter, as intended. Kennedy’s estate tried to argue that his ex-wife had lost her rights through a state court divorce decree, but the court found that only a QDRO could effectively remove Liv’s right to the account.
ERISA can have unintended consequences, but its reach is limited, which can cause even more problems. Individual retirement accounts (IRAs) are required to distribute funds to the IRA owner under the ERISA rules, but an IRA owner can change his or her beneficiary designation without the spouse’s permission, as is required under ERISA for private business retirement plans. Thus, a spouse moving his or her retirement account from a company sponsor to a private sponsor can designate a ‘dear friend’ in place of a spouse without the spouse’s consent or knowledge, depriving the spouse of security after the IRA owner passes away.
ERISA does not apply to government sponsored plans. Retirement benefit plans, such as 403(b)s, Thrift Saving Plans (TSPs), 457 deferred compensation plans, and railroad benefit plans, are considered government sponsored plans. Thus, if state law declares that an ex-spouse’s rights to plan benefits terminate upon divorce, the beneficiary designation naming the ex-spouse as the benefit’s recipient will not supersede state law.
What can you do?
- Keep those beneficiary designations updated. It is a prudent practice to check the beneficiary designations at major life events, such as marriage, divorce, or the birth of a child, and at least every five years. Not naming a beneficiary should not be an option. For most plans, the default beneficiary, if there is none listed, is your probate estate. The problem with your estate receiving the funds is that if a lump sum is the only form of distribution allowed by the plan, income taxes will be due when the funds are distributed.
- Beneficiary designations on retirement accounts may not be right for your situation. If you designate a minor, a person with special needs, an elderly parent, an individual with creditor problems, or someone with an unstable marriage, you may be inadvertently depriving individuals of public benefits or allowing the money to go towards paying credit card debt instead of providing an income stream or security for the individual.
- Fill out the beneficiary designation correctly. People may change their names after marrying, and many names are similar (John Smith Jr. may not be the same as John Smith II, and neither is John Smith Sr., but it may be John Smith), which can create confusion, delay, and sometimes litigation.
- Consult your financial and legal advisor about completing beneficiary designations. Many times, the beneficiary designations must coordinate with the distributions in your estate planning, and your advisors should be aware of those designations in order to coordinate with your estate planning.
If you have questions about how beneficiary designations work for both private and government retirement plans, please contact me to set up a time to discuss the matter. Kathleen Adcock, Esquire, kadcock@mcmillanmetro.com or call me directly at (240) 778-2316.
