Check your beneficiary designations

posted 1/14/2014 in Trust

As the new year begins, it’s a good time for going over one’s estate plans. The amount exempt from the federal estate tax grows to $5.34 million this year, which should excuse the vast majority of 2014 decedent estates from owing anything. However, nontax circumstances may have come into play, rendering a will less than fully effective. For example, there may be new heirs to consider, or asset values may have changed in a way that now causes the testamentary plan to veer from the original intention. If that might be your situation, a will review is called for.

Having a will is important, but having a will is not enough. Another key item that controls the passage of one’s property at death is the beneficiary designation. Life insurance proceeds, retirement plan accounts and IRAs are all examples of property that will not pass through the probate estate unless the estate itself is designated as the beneficiary. These need to be reviewed from time to time, and marking the beginning of the new year as the checkpoint should keep them in accord with one’s wishes.

Even a well-planned beneficiary designation may go awry, as a recent court case shows. Leonard Kidder named his wife to be the sole beneficiary of his company’s 401(k) plan at his death. However, his wife died before Leonard did. He then updated the beneficiary designation, naming his three children to share the account equally.

So far, so good. Some years later, Leonard remarried. He didn’t change his beneficiary designation, but the law known as ERISA did. To comply with ERISA, the company 401(k) plan provided that a surviving spouse will inherit any plan balance unless the spouse has filed a waiver of his or her rights. Leonard’s second wife did not file such a waiver. Although they had been married for just six weeks when Leonard died, the second wife claimed the 401(k) balance as hers.

The children objected, but to no avail. The plan terms were clear and unambiguous. ERISA allows for a one-year waiting period for spousal rights to vest, but does not require such delay. Leonard’s plan did not include a waiting period. If Leonard really wanted to preserve the inheritance for his children, he needed to take appropriate steps before he remarried.

401(k) versus IRA

The outcome was different in another court case pitting a second wife against children from a first marriage. Wilson began living with Chandler in 1990. In 1994 he took a lump sum distribution of his 401(k) money and rolled it into an IRA. He made additional IRA contributions from 1995 to 1999. Wilson and Chandler married in 2000.

Two years later, anticipating a possible divorce, Wilson transferred half of the IRA money into a new account. His four adult children from a previous marriage were the beneficiaries of this account. Wilson died in a flash flood in 2005, at age 65, before getting divorced. Chandler filed suit to claim all the IRA money, alleging that Wilson could not deny her the right to the funds that originated in an ERISA-qualified plan.

Not so, the Court ruled. The spousal rights accorded to ERISA plans do not extend to IRAs. What’s more, in this case the rollover of the funds to the IRA occurred long before the marriage took place, so there was no spousal consent possible when the transfer was made.

Don’t leave it to chance

We can be pretty confident that Wilson achieved the result he intended with his IRA. About Kidder there is less certainty. Did he know that his new wife would get his 401(k), and so would have been happy with the result? If so, he would have been well advised to have changed the beneficiary designation, in order to remove all doubt and avoid the expense of litigation. On the other hand, perhaps Kidder was ignorant of the plan rules that vested his 401(k) money in his wife upon the moment of his remarriage. Consultation with an estate planning attorney might have set him straight.

When you are meeting with your estate planning advisors, don’t overlook the importance of beneficiary designations in the implementation of your testamentary plans.

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