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Divorce, Beneficiary Designations, and Retirement Accounts

Here's why it's so important to update beneficiary designations after a divorce.

Natalie Choate, 06/09/2017

Question: Ed and Ted were both employees of Acme Inc. Both recently became divorced from Polly and Molly, respectively. In the division of their respective marital assets, each man kept his 401(k) benefits and IRA account. Following the divorce, Ted married Dolly. Then Ed and Ted died in a car accident on a fishing trip. Never too concerned about legal paperwork, neither man had updated his beneficiary designations--Polly and Molly were still named as primary beneficiaries of their Acme 401(k) plan accounts and IRAs, with each man's children as contingent beneficiaries. Now Molly, Polly, Dolly, and the children want to know, who gets the money?

Answer: Here's the short answer: The plan documents are in control. In the case of the 401(k) plan, the terms of the plan documents are partly dictated by federal law. In the case of the IRAs, the terms of the IRA agreements may be partly "overruled" by state law.

Now let's untangle the mess.

Ed's 401(k) plan: Ed had named his now-former-wife Polly as his beneficiary before the divorce. He never changed that beneficiary designation. There is no federal law dictating that divorce revokes a beneficiary designation of the ex-spouse. Therefore, unless the 401(k) plan document itself says that divorce revokes the beneficiary designation (which would be, I believe, very unusual), ex-wife Polly is entitled to Ed's 401(k) money. If she signed away her rights to those benefits in the divorce agreement, the children may be able to sue her and get that money away from her--but the divorce agreement between Ed and Polly is not binding on the 401(k) plan. The plan pays the benefits to the named beneficiary, period, end of discussion. Except in Ted's situation ...

Ted’s 401(k) plan: Ted had named his now-former-wife Molly as his beneficiary before the divorce. He never changed that beneficiary designation. As we saw with Ed, there is no federal rule dictating that divorce revokes a beneficiary designation of the ex-spouse. However, Ted remarried, and there is a federal law that says the surviving spouse is automatically entitled to 100% of the death benefit under a 401(k) plan unless he or she has consented to naming a different beneficiary. (That’s an oversimplification, but most 401(k) plans take the least complicated path and simply dictate that the surviving spouse is the automatic beneficiary, even if in a particular case federal law would not actually so require.) Therefore it is almost certain that under the terms of the 401(k) plan document (as shaped by federal law), new wife Dolly is entitled to Ed's 401(k) money. If she agreed (in a prenuptial agreement) not to claim that money, the children might be able to bring a lawsuit and get that money away from her, but the prenuptial agreement is not binding on the 401(k) plan. Federal spousal rights cannot be waived in a prenuptial agreement!

Ed's IRA: Ed had named his now-former-wife Polly as his IRA beneficiary before the divorce. He never changed that beneficiary designation. IRAs are not subject to the federal ERISA law that creates spousal rights in pensions and "pre-empts" state inheritance laws. Under many states' laws, divorce revokes a beneficiary designation in favor of the ex-spouse--the ex-spouse is deemed to have predeceased the IRA owner. An applicable state law to that effect should operate on the IRA. But the question will be, which state's law applies? The law of the state Ed was domiciled in? The law of the IRA provider's state of incorporation? Since IRAs first came on the scene in 1974, estate lawyers have speculated about conflicts of state inheritance laws that could potentially apply to inherited IRAs, yet surprisingly, there has been little reported litigation of questions like this.

Ted's IRA: Ted's IRA has the same questions and answers as Ed's IRA, but with one added layer of complication. Since Ted had remarried, Dolly (as the widow) may have inheritance rights to Ted's IRA under state law, regardless of whether the applicable state law (whichever state's law that might be) caused the designation of Molly to be revoked by the divorce.

As you can see the three wives and the children may have plenty to argue about here. The confusion could have been avoided if Ed and Ted had spent a little time updating their beneficiary designations before they went fishing.

Natalie Choate will be speaking in: Akron, OH (6/13/17); Indianapolis, IN (9/13/17); San Diego, CA (10/27/17); Philadelphia, PA (11/14/17); Plymouth, MI (12/7/17); and Orlando, FL (Jan. 25-26, 2018). See all of Natalie’s upcoming speaking events at http://www.ataxplan.com/seminars/schedule.cfm

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Natalie Choate practices law in Boston with Nutter McClennen & Fish LLP, specializing in estate planning for retirement benefits. Her book, Life and Death Planning for Retirement Benefits, is a leading resource for professionals in this field.

The author is not an employee of Morningstar, Inc. The views expressed in this article are the author's. They do not necessarily reflect the views of Morningstar. The author is a freelance contributor to MorningstarAdvisor.com. The views expressed in this article may or may not reflect the views of Morningstar.

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