Many Americans plan for retirement, as well as for their loved ones’ future without them, with retirement plans such as 401(k)s and Roth IRAs. Thanks to the Employee Retirement Security Act (“ERISA”), there is a simple way to transfer these assets as part of an estate plan: the accountholder just needs to designate a beneficiary or beneficiaries using documents provided by the plan and the plan administrator MUST distribute the assets according to the designation. However, ERISA’s simplicity can create substantial problems in an estate plan. More specifically, what happens when the beneficiary designations do not match what everyone believes the accountholder would have wanted? For example, what if the accountholder (i) gets divorced, (ii) remarries after the death of a spouse, or (iii) never makes a designation at all? The answers may surprise you.
When a couple gets divorced, the court may divide retirement accounts as assets of the marital estate. As a final part of this division, spouses will typically waive any rights they have in the retirement accounts of the other. While this seems simple enough, keep in mind that these waivers typically are only related to spousal rights and not the account assets. In other words, after a spousal waiver, the former spouse becomes just like any other beneficiary who may receive the account based on the most current beneficiary designation. Therefore, if the accountholder does not update the beneficiaries after the divorce and continues to name the former spouse, then the former spouse will receive the account.
A typical arrangement for a married accountholder is to list the spouse as the primary beneficiary on death, with any children as contingent beneficiaries. If the accountholder’s spouse predeceases the accountholder and the accountholder remarries, this can cause several problems. First, the second spouse WILL NOT be a beneficiary, regardless of the accountholder’s wishes. Second, if the beneficiary designations are not updated, then there can be confusion among the surviving family members regarding the accountholder’s wishes, leading to unnecessary conflict. Finally, if the accountholder has children with the second spouse, those children WILL NOT be beneficiaries of the account.
Failure to Make a Designation
Each retirement plan has its own provisions for what happens to the account assets when the accountholder fails to designate a beneficiary. Most plans provide that the assets will pass according to state law governing intestate succession. In Colorado, this usually means a person’s closest-living relatives, with a spouse having the highest priority followed by children. These default rules can have profound consequences for couples who are not married. For example, if the accountholder (i) never marries a long-term companion (and common law marriage is not available), (ii) has only one surviving relative, an estranged brother, and (iii) never designates a beneficiary on his $3 million 401(k), then the estranged brother WILL inherit the entire account.
When it comes to retirement plans, just remember one simple rule: the plan administrator will give the assets to the beneficiaries you list on a designation form. If your beneficiaries change, you cannot rely on common sense to change your beneficiary designations for you. You must do it yourself.
The advice given in this post is educational and provides only a general overview. If you have questions about your specific situation or would like to speak with one of our estate planning attorneys, please contact Alex Kirven at 720-443-4892 or by sending an email.