Financial advisors and their clients often fail to realize that an outdated retirement account beneficiary designation form has the power to trump a will during the probate process.
In fact, as discussed by financial planning experts Ed Slott and Jeff Levine during the latest episode of their podcast series, "The Great Retirement Debate," there are a significant number of cases in which outdated beneficiary designations have resulted in the loss of millions of dollars of anticipated retirement assets by surviving spouses. In some situations, substantial amounts of money have been redirected to former romantic partners or estranged in-laws, putting emotional strain on close family members.
As such, it is crucial for financial advisors to check in with their clients who have substantial savings in retirement accounts protected by the Employee Retirement Income Security Act with respect to their beneficiary designations. While there are general beneficiary rules in place at the federal level, the experts warned, there are nuances to consider at both the state and local levels.
“When in doubt, fill one out,” Levine said. “It never hurts to go back and reaffirm your beneficiary designations in order to make sure your intentions remain clear and accurately recorded over time. Failing to do so can result in an inheritance nightmare.”
What Can Go Wrong?
Levine and Slott pointed to a recently decided tax court case in which a deceased man had neglected to update a beneficiary designation originally made in the mid-1980s, in which he named his then-girlfriend as the beneficiary. The account, which was valued at more than $1 million, was transferred to the former girlfriend upon the man's death, raising the ire of the deceased's two surviving brothers.
“Despite the fact that he broke up with her in 1989, he never made a beneficiary change in all those years, even after being invited to do so on numerous occasions,” Slott explained. “The initial beneficiary designation, in fact, was actually written on a paper card, but the election was still valid at the time of his death.”
Importantly, this individual was never married and did not have any children at the time of his death.
“So, the ex-girlfriend got the money, plain and simple,” Slott said. “That’s just the law, and unfortunately for the deceased man’s two brothers, they really don’t have any recourse. They lost the initial tax court case, and my view is that they are certain to lose any appeal they might make.”
Even if the judge agreed with the brothers’ assertion that the deceased man likely did not intend for the money to go to the former girlfriend, it doesn’t matter under the law. The beneficiary designation can’t be overruled in this circumstance.
“Maybe giving the money to the ex-girlfriend was his true intent,” Slott said. “What it comes down to is the importance of communication well ahead of inheritance events. It’s operational law. The designation form is a contract that no company or court has the power to change once the account owner has died.”
Such a valid beneficiary designation made in an ERISA-covered plan would override a valid will during probate, Levine and Slott noted.
“It’s that powerful,” Slott warned. "So, we have to get beneficiary designations right."
Ex-Spouses Are Treated Differently
An important distinction, according to Slott and Levine, is that former spouses are treated differently from former girlfriends or former boyfriends in these situations.
If a person in an ERISA-covered retirement plan gets married, the plan administrator must rename their spouse as the new beneficiary within a year. There’s no choice under the law, unless the new spouse agrees in writing to waive their standing as the new beneficiary.
Crucially, if this couple eventually gets divorced, the now-former spouse is also disinherited from the account in most states. The person who is named as the new beneficiary can vary by jurisdiction, so it’s key for advisors and clients to study the rules in their particular location.
“Many states, upon divorce, have an automatic revocation of the ex-spouse’s beneficiary designation — unless the spouse who owns the account renominates that person as the beneficiary,” Levine observed. “There was a Supreme Court case that established this framework. They declared that the ex-spouse must be renominated to retain their inheritance claim to the account.”
The best practice in all cases, according to the duo, is to actively make a new election so as to avoid any potential misunderstandings. This is true even if the intended beneficiary is also the automatic beneficiary under the local jurisdiction.
"It's all about avoiding ambiguity and surprises," Levine said. "For advisors, it's a good practice to check in with their clients on this every time there is a major life event, such as a marriage, the birth of a new child or grandchild, etc."
IRAs and Non-ERISA Accounts
Adding another layer of complexity is that individual retirement accounts and non-ERISA retirement accounts such as government-sponsored 403(b) plans have their own set of rules.
These accounts are not subject to ERISA protections, and so there is no automatic reassignment of the beneficiary designation upon a new marriage. Whatever prior beneficiary designation was made will remain in place and must be actively changed.
“So, let’s say a person had named their ex-girlfriend as their IRA beneficiary, but they later get married and have kids,” Slott said. “Well, neither the new spouse nor the kids automatically get any claim or title to the assets in the IRA. They will only get a claim to the money if the owner proactively updates their beneficiary designation.”
Levine recalled a case from 2005 in which a surviving spouse missed out on more than $1 million in benefits he expected to inherit upon his wife’s death. She had worked for the New York City school system and had her assets in a non-ERISA-covered 403(b) plan.
“As it turns out, she had set this account up years before she met her husband, and she had named her mother, uncle and sister as the beneficiaries,” Levine said. “Fast-forward several decades to her death, and it turns out she never updated her beneficiary form. By law, the money had to go out according to the beneficiary designation, so it went to the sister.”
As in the prior case, the surviving spouse may have garnered a lot of public sympathy but didn’t have any legal remedy.
Pictured: Jeff Levine and Ed Slott
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