Anyone who counsels clients in investment or estate-planning matters knows the importance of regularly reviewing beneficiary designations on qualified retirement accounts to one day assure the smooth and intended transfer of assets. However, most Americans don’t regularly seek professional counsel on these matters. Instead, they’re left to navigate obligatory forms that leave them largely handicapped in their planning through the lack of clear information and the rigidity of today’s inheritance law regarding these investment accounts.
In “Accidental Inheritance: Retirement Accounts and the Hidden Law of Succession,” Professors Stewart E. Stark and Melanie B. Leslie bring the burdens of estate planning for qualified plans to the attention of the broader legal community. They note that: (1) the inheritance of individual retirement accounts and qualified retirement plans is governed by plan documents and existing law, not individual will and estate plan intent, and therefore, (2) it’s critical to regularly review specific plan beneficiary designation forms with clients. The professors further explore the complexity, confusion and challenges account holders may encounter without experienced counsel, and they suggest potential remedies.
Profs Stark and Leslie begin with a short historical perspective. They point out that in 1974, Congress enacted the Employee Retirement Income Security Act (ERISA) establishing IRAs and employee-sponsored defined contribution retirement plans, allowing for the slow demise of the historically popular defined benefit pension plan. Defined benefit plans, by definition, paid out immediately on retirement or over the remaining life of the beneficiary, thereby escaping any estate-planning issues. ERISA also envisioned an employee-built retirement nest egg that would be consumed over a person’s lifetime. However, Profs Stark and Leslie report that, 40 years after their introduction, IRAs, 401Ks and other qualified employee contribution plans aren’t being fully consumed by many participants and have, in fact, become the single largest source of wealth for Americans behind their primary residences. According to the authors, the cumbersome and often unclear rules for the transfer of these assets at death will become an increasing problem for beneficiaries and plan custodians.
A review of the inheritance law governing these plans offers the professors the opportunity to highlight current difficulties. A major convenience of retirement accounts is that under current law, they pass to beneficiaries outside of probate. When beneficiary designations are kept up-to-date and are accurate as to the accountholder’s intent, all is well. However, as the authors point out, accountholders often don’t update these forms after major life events, and the assets may then not pass as intended.
For employee-sponsored plans, federal ERISA law is very clear that assets must be distributed as expressly stated in the plan document, regardless of any estate documents that establish different accountholder intent. Further, ERISA distinctly directs that an accountholder’s indicated spouse has survivorship rights, unless the spouse expressly waives her rights. ERISA also supersedes any state law on this issue.
In contrast, IRAs are covered by state law, which can vary widely. Many states have adopted the Uniform Probate Code, and Section 2-706(b) attempts to address the problem of differences in an IRA designation and estate document intent. If no effective beneficiary is designated, anti-lapse provisions can be extended from will provisions. However, if a secondary beneficiary has been designated, the anti-lapse provision doesn’t apply, no matter the intent of the accountholder’s will.
While these laws aren’t generally problematic when beneficiaries have been properly designated, the authors share several examples of the potential frustrating legal battles that can occur when designations haven’t been updated after typical life events, such as marriage, divorce and birth.
To properly identify beneficiaries, accountholders must correctly complete a beneficiary designation form provided by the plan sponsor or the custodian. Profs Stark and Leslie surveyed a sampling of the most common beneficiary designation forms and concluded that these forms are the source of most estate intent problems with the transfer of retirement assets. Their survey revealed that the first limiting factor is that the forms are generally standardized, making it very difficult to communicate specific estate-related instructions beyond named individuals and the most basic of trust designations. More importantly, the forms fall far short when it comes to fully informing and educating the accountholder as to the importance of a beneficiary designation. None clearly explain that the form will supplant any instructions in an accountholder’s will; none have language to help participants understand the consequences of out-of-date beneficiaries or no designation at all; and no form emphasized to accountholders that a properly completed form is the only way to designate or change beneficiaries throughout the accountholder’s life.
The authors’ proposed remedies for improving the law of retirement plan succession are good discussion openers. They suggest that much can be accomplished with improved and standardized beneficiary forms. They recognize, however, that there’s no mechanism to force a change with plan administrators of custodians. Their hope is that if a single state can mandate better disclosure and informational requirements, all market participants would adopt the changes across the country for ease of administration. The authors also recognize that changes to qualified employee-sponsored plans will be much harder, as any changes currently would require amending federal law.