401(k) rights trumped by ERISA

In a recent case (Cajun Industries LLC v. Robert Kidder, et al.), the court ruled that despite having previously named his three children as beneficiaries of his 401(k) plan, a deceased plan participant’s 401(k) balance will pass to his new wife. The court determined that under the terms of the participant’s plan, a spouse’s right to plan assets is immediately vested upon marriage, and since no spousal waiver was obtained, the default beneficiary is the spouse, even though she was not the named beneficiary.

The spouse got the 401(k), and the children, who were the intended beneficiaries, were disinherited.

FACTS OF THE CASE

Leonard Kidder was a former employee of Cajun Industries LLC and was a participant in the company’s 401(k) plan. Mr. Kidder originally named his wife, Betty Kidder, as the sole beneficiary of his plan, but after her death, Mr. Kidder updated his form, naming his three children as the new beneficiaries of his plan.

In late 2008, Mr. Kidder married Beth Bennet Kidder. Just six weeks after the marriage, Mr. Kidder died. During those six weeks, no waiver of spousal rights was made for Mr. Kidder’s 401(k) assets. Following his death, a dispute arose between Beth Bennet Kidder and Mr. Kidder’s three children, with each side claiming that they were the rightful beneficiaries of Mr. Kidder’s 401(k) plan.

The children claimed that they, as the named beneficiaries on the most up-to-date form, were entitled to the funds. On the other hand, Beth Bennet Kidder claimed that as Mr. Kidder’s wife, she was entitled to the funds, regardless of what the beneficiary form said.

THE COURT’S DECISION

The court had little difficulty in determining that Beth Bennet Kidder was the rightful plan beneficiary. First, the court noted the plan’s language was “clear and unambiguous” that unless a spousal waiver were executed, a deceased participant’s vested interest would belong to his or her spouse. Next, the court addressed the Employee Retirement Income Security Act of 1974 issue raised by Mr. Kidder’s children. In the court’s view, it was clear that although ERISA allows plans to waive spousal consent requirements when a participant has been married less than a year, it does not require that they do so.

When it comes to retirement accounts, the beneficiary form is the most important document there is. It takes precedence over prenuptial agreements, postnuptial agreements and even contrary instructions on who should inherit plan assets contained in a client’s will. But the decision in the Kidder case makes it clear that when it comes to ERISA plans, the beneficiary form can be trumped by spousal rights.

When it comes to estate planning, individual retirement accounts typically offer clients far greater benefits than plans do. One of those benefits is under IRA rules, the beneficiary can be someone other than a spouse (some exceptions apply in community property states). Instead, the IRA owner can pick whomever he or she chooses. In fact, a single IRA often is split into into multiple IRAs, each with a separate named beneficiary.

So what about clients who are currently married and have 401(k) accounts but would like to leave their retirement funds to someone other than his or her spouse? Can the owner simply roll the plan funds to an IRA and name a new beneficiary without the spouse knowing, thereby disinheriting him or her? The answer is generally no. Most distributions from 401(k)s and other ERISA plans, including direct rollovers to IRAs, require spousal consent. Once consent is received and the funds are in an IRA, the owner is free to update their beneficiary form as he or she pleases.

Had Leonard Kidder rolled his 401(k) to an IRA after leaving Cajun Industries, but before his remarriage, this unfortunate incident would have been avoided. After Betty Kidder’s death, Mr. Kidder could have put the funds in an IRA and name his three children as beneficiaries (in the same manner as he did with his 401(k) plan). When he married his new wife, the children would have remained the beneficiaries of his account. He also could have asked his new wife to waive her rights to the 401(k) plan, but that did not happen, and there is really no way to guarantee that Beth Kidder, or any other spouse, for that matter, would waive their spousal rights to plan assets.

Advisers should make sure that clients with assets in ERISA plans are aware of the special rule requiring spousal consent in order to name their children (or any other non-spouse) as a beneficiary of that plan.

Ed Slott, a certified public accountant, created The IRA Leadership Program and Ed Slott’s Elite IRA Advisor Group. He can be reached at irahelp.com.