Put Your Plan in Order. Part 1: Are Your Beneficiary Designations Current?

Put Your Plan in Order. Part 1: Are Your Beneficiary Designations Current?

This week’s article, “Are Your Beneficiary Designations Current?” is the first in a series of four articles discussing key information on estate planning matters. The following articles will also be included in this series:

                Part 2: Updated Planning for Clients with Married Separate Trusts

                Part 3: Basic Estate Planning for Single Adults and Simple Estates

                Part 4: Fund Your Living Trust. Strategies for Individuals with Trusts

Be sure to make reviewing your estate plan part of your holiday to-do list, or include this task in your New Year’s resolutions.

 Put Your Plan in Order

Part 1:  Are Your Beneficiary Designations Current?

Assets with beneficiary designations are typically life insurance policies and retirement accounts, including individual retirement accounts (IRAs) and qualified plans such as 401(k) plans.

Beneficiary designations typically override any beneficiary provisions made in a person’s last will and testament or living trust agreement. As a result, a careful review of your beneficiary designations on life insurance policies and retirement accounts is important. Listing contingent beneficiaries in case an individual beneficiary predeceases you is also advisable.

Avoid certain rules or laws that may result in beneficiary-designated assets being distributed contrary to your intentions. For example, if you fail to list any beneficiary designation, or list a beneficiary who predeceases you without a contingent beneficiary, the asset distribution defaults to your estate. Whatever instrument that controls the disposition of your estate assets, such as your will or trust, would then govern who receives the asset. This may or may not be acceptable.

Divorced individuals need to take particular care in reviewing assets with beneficiary designations. Although Michigan, like many states, has a statute that revokes a beneficiary designation in a death benefit to a former spouse where there has been a change in the decedent’s marital status. That may be fine for descendants who have remarried, but it doesn’t help a divorced individual who is not remarried and is single at the time of his/her death with a previous spouse listed as beneficiary of a retirement account or life insurance policy.

Aside from state law, there are various federal laws and regulations with respect to retirement plans, defined as “ERISA” plans, subject to federal regulations that govern almost all 401(k) and related type plans. These regulations provide that an individual’s “spouse” must be the primary beneficiary unless the spouse signs a waiver form allowing for the appointment of another primary beneficiary. In some instances, individuals may want someone other than their spouse to be a beneficiary, such as in certain second marriage situations. Also, where an individual is divorced and fails to change the beneficiary in a plan governed by federal law (retirement plan or, in some instances, life insurance for federal employees), that can also lead to unintended consequences.

Consider the following case that was decided by the U.S. Supreme Court. During his lifetime, an individual named Warren designated Judy, his wife at the time, as a named beneficiary in his 401(k) plan. In 1998, thereafter, the couple divorced and approximately four years after the divorce, Warren married Jacqueline. Warren died suddenly six years later without ever having changed the named beneficiary from Judy to Jacqueline. As a result, the ex-wife, Judy, filed a claim as beneficiary of the retirement account and the Plan Administrator distributed proceeds to her.

Jacqueline sued Judy in a state court to recover the proceeds, supporting her claim with much more than a supposition that Warren“would have wanted it that way.” In short, she claimed with some justification to have state law on her side whereby a state statute revoked a beneficiary designation in any contract that provided a death benefit to a former spouse where there had been a change in the decedent’s marital status. In addition, the state statute even provided that if the state law provision was “preempted by federal law,” a separate provision of a state law provided cause of action making the former spouse liable for the principal amount of the proceeds paid to the party who would have received them if the first provision were not preempted.

The U.S. Supreme Court sided with Judy, the former wife, notwithstanding there was certain logic to the position that Warren most likely would have preferred that the proceeds go to his wife at the time of his death. The unassailable fact was that though he had 10 years after his divorce from Judy and six years after his remarriage to Jacqueline to do so,Warren never changed the named beneficiary on his retirement account.

Simply put, if a beneficiary, Judy in this case, is properly named as a beneficiary of the plan, then the proceeds owed to that person cannot be allocated to another person, in this case Jacqueline, by operation of state law. Apart from the legal precedent this case set, the case is also an object lesson of the importance of keeping one’s estate plans, including beneficiary designations, current. Had Warrentaken the simple step of filling out the form to change beneficiaries on his retirement account before he died, assuming that was his wish, the protracted litigation that ensued after his death and unintended distribution of proceeds to his first wife would have been avoided.

The impact of all of the various laws and rules concerning the payment and distribution of proceeds from life insurance policies and retirement accounts becomes less important if proper care is used by the individuals to designate the proper individuals as beneficiaries. This avoids distributions being governed by laws that may not consider the intention of the individual who actually owns the insurance policy or retirement account.