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The little mistake that could destroy a life insurance plan

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In a recent U.S. Supreme Court case (Hillman vs. Maretta, U.S. Supreme Court, No. 11-1221, June 3, 2013) the Court ruled that a decedent’s ex-spouse, who was still named as his beneficiary, was entitled to receive his federal life insurance benefits. The decision was unanimous, despite the fact that an applicable state law says that an ex-spouse is removed as the beneficiary of a decedent’s various death benefits after divorce. As a result of poor planning, the intended beneficiary was disinherited. No advisor wants this happening on their watch.

In 1996 Warren Hillman named his then-wife, Judy Maretta, as the beneficiary of his Federal Employees’ Group Life Insurance (FEGLI) policy. Two years later, however, the couple divorced.

In 2002, Hillman married Jacqueline. The two remained married untilWarren’s unexpected death in 2008. Despite having divorced Judy some 10 years earlier, and having been married to Jacqueline for six years,Warrennever updated his FEGLI beneficiary form and so, on the date of his death, his ex-wife, Judy, was still his named beneficiary.

While Judy (the ex-wife) was clearly the named beneficiary, thanks to a series of conflicting federal and state laws, a dispute ensued that ultimately called into question who was the rightful recipient of the FEGLI benefits.

AVirginiastate law directly opposed Hillman’s beneficiary designation. Under the law, when a couple divorces, they are no longer treated as one another’s beneficiaries, even if their beneficiary forms say otherwise. This, on its own might lead one to think that Judy would no longer be entitled to receiveWarren’s FELGI benefits.

However, an applicable provision of the Federal Employees’ Group Life Insurance Act (FEGLIA), the federal law that created FEGLI benefits, further contradicts the Virginiastatute. Part of that law explicitly states that its FEGLI contract provisions supersede any state laws that may differ. In that case, the FEGLI beneficiary form would, once again, control who received the benefits.

The U. S. Constitution contains a provision known as the “Supremacy Clause,” which establishes the Constitution and other federal statutes as the supreme law of the land. Under this provision, when federal law and state law are pitted against one another, the federal law is given preference.

U.S. Supreme Court Decision

On June 3, 2013 the U.S. Supreme Court resolved the issue for good, deciding unanimously, 9-0, to affirm the Virginia Supreme Court’s decision to award Judy the FEGLI benefits. In the Court’s opinion, the Virginiastatute holding Judy liable to Jacqueline for the FEGLI benefit “interferes with Congress’ scheme, because it directs that the proceeds actually ‘belong’ to someone other than the named beneficiary…”

The Court also pointed out that many people fail to properly update their beneficiary forms and that this was something Congress has been aware of. Therefore, had Congress desired that FEGLI benefits be awarded to someone other than a person named on the beneficiary form — say, perhaps, a current spouse — they could have passed legislation to do so. Finally, the Court noted that to decide otherwise would be viewing the FEGLI statute so narrowly that states could easily create laws to work around its true intention.

In its decision, the U.S. Supreme Court cited two cases in which it decided in a similar fashion. The cases, Wissner v. Wissner (1950) and Ridgway v. Ridgway (1981), both dealt with state statutes that tried to override federal laws that are “strikingly similar to FEGLIA.” In both cases, the Court held that the federal law trumped any conflicting state statute and that the beneficiary named on the beneficiary form trumped other interests.

Similarly, in 2009 the U.S. Supreme Court, in Kennedy v. DuPont, decided that despite having waived her rights in a valid spousal waiver, the ex-spouse of a plan participant was entitled to funds intended to be left to his daughter, because she was still the named beneficiary. That decision was also unanimous. The daughter in that case was disinherited from $402,000 of her father’s 401(k) that he wanted to go to her because he never updated his 401(k) beneficiary form after his divorce. His ex-wife, who was also the daughter’s mother, received the funds because she was named on the beneficiary form.

The U.S. Supreme Court decision does not say that state statutes, such as the one inVirginia, can’t be applied to other assets with death benefits, such as IRAs, when there are no competing federal laws.

The common thread running throughout the Hillman, Wissner, Ridgway and Kennedy cases is this: The decedent’s wishes were not carried out and long court battles ensued, all because no one ever took the time to update a simple beneficiary form. These are very preventable mistakes that, with a small amount of effort, can be avoided.

Advisors must make sure to conduct regular beneficiary form reviews to avoid similar problems for their clients.

The Hillman case makes it clear that advisors should never rely on “default” provisions if they don’t have to. Why rely on state law or a custodial contract to avoid having life insurance, IRAs or other assets pass to an ex-spouse, or other unwanted beneficiary, when the same result can be accomplished with certainty simply by updating the beneficiary form?

See also:

The biggest IRA mistake

Obama’s budget calls for big changes to 401(k)s, IRAs

2013 Life Insurance Survey: The results