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In the recent case of Kennedy v. Plan Administrator for DuPont Savings and Investment Plan et al.,1 the U.S. Supreme Court again confirmed its longstanding policy that qualified retirement plans (QRPs) must be administered in accordance with the plan documents (and without regard to extraneous documents or contravening state laws). Though the opinion is encouraging with respect to disclaimers of QRP benefits, estate planners still must proceed with caution regarding such disclaimers.
Do Disclaimers Violate ERISA?
ERISA, which stands for the Employee Retirement Income Security Act of 1974, refers to the constellation of requirements that apply under the U.S. Code to “employee pension benefit plans” (usually called “retirement plans”) as defined in 29 U.S.C. Section 1002.2 Many clients have retirement benefits in plans, such as 401(k) plans, that are subject to ERISA.
ERISA generally preempts state law when federal and state law conflict. Past Supreme Court cases have allowed plan administrators to ignore state property and probate laws, citing ERISA's requirements. Because disclaimers are creatures of state property law, estate planners have been concerned that a plan administrator of a QRP might cite ERISA in refusing to recognize a disclaimer. The fear is that a plan administrator might take the position that the plan requires the benefits to be paid to the beneficiary named by the participant, and the plan has no authority to pay the benefits to someone else if the named beneficiary is in fact living.
There are two specific ERISA-related concerns regarding the enforceability of a disclaimer with respect to a qualified retirement plan: Does a disclaimer violate the “anti-alienation rule”? And, does the disclaimer contravene the terms of the plan document?
The Anti-alienation Rule
One of the requirements a retirement plan must meet to be “qualified” under Section 401(a) of the Internal Revenue Code is that the plan document must provide that benefits under the plan “may not be assigned or alienated,” except through the medium of a qualified domestic relations order (QDRO),3 which is a court-ordered transfer of benefits between spouses in connection with a divorce.4 This “anti-alienation rule” is also a requirement applicable to retirement plans under ERISA.5
From one perspective it might appear that a disclaimer violates this rule. By refusing to accept the benefits, the beneficiary in effect causes the benefits to pass to someone else. In Kennedy, however, the Supreme Court ended any concern that may have existed on this point.
In Kennedy, the participant, William Kennedy, designated his then-spouse, Liv, as beneficiary of his death benefits under a certain DuPont retirement plan. Upon their subsequent divorce, Liv waived her rights to this benefit as part of the parties' divorce agreement. The divorce agreement, though apparently valid and enforceable between the parties, did not rise to the level of a QDRO. William never subsequently changed his beneficiary designation. Accordingly, the beneficiary designation form naming Liv as beneficiary was still on file with the plan at his death. The plan paid the benefits to Liv as the named beneficiary, over the protests of William's daughter (and executrix) Kari. Kari sued the plan, claiming the benefits should have been paid to the estate (as default beneficiary under the DuPont plan) because Liv had waived her rights to these benefits.
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The plan made several arguments as to why it was not obligated to honor Liv's waiver of the benefits in the divorce agreement. One of these was that the waiver violated the anti-alienation rule. The court rejected this argument. The court held that a beneficiary's giving up the right to an inherited benefit under a qualified plan does not constitute an assignment or alienation that would be void under IRC Section 1056(d)(1), provided the beneficiary does not attempt to direct where the inherited benefit will go. According to the Kennedy court, “Common sense and common law both say that ‘[t]he law certainly is not so absurd as to force a man to take an estate against his will.”6
Although Kennedy dealt with a divorcing spouse's waiver of her rights to benefits under her ex-husband's plan, the same principle would apply to a disclaimer which, under federal tax law, must not involve any direction by the disclaimant regarding who shall inherit the asset as a result of the disclaimer.7 In fact, the court compared the spousal waiver to a disclaimer, pointing out that the law of trusts serves as a backdrop to ERISA, and “the general principle that a designated spendthrift beneficiary can disclaim his trust interest magnifies the improbability that a statute written with an eye on the old law would effectively force a beneficiary to take an interest.”8 The plan involved in Kennedy had a specific provision permitting disclaimer, which the court quoted favorably; this should lay to rest any notion that a disclaimer violates ERISA's anti-alienation requirement.
The IRS also has recognized that disclaimers do not violate ERISA,9 and has blessed disclaimers of QRP benefits in numerous private letter rulings.10
Accordingly, there should no longer be, if there ever was, any concern that a disclaimer, per se, violates the anti-alienation rule. The next question is whether giving effect to the disclaimer would violate some other requirement applicable to qualified plans.
The Plan Document
Another ERISA requirement applicable to QRPs is that the plan administrator must administer the plan in accordance with “the terms of the plan.”11 The Supreme Court twice has held that this ERISA rule preempts any state law that would require the plan administrator to deviate from the terms of the plan document:12
- In Egelhoff v. Egelhoff,13 the named beneficiary under the plan was (as in Kennedy) the participant's ex-spouse. Under Washington state law, which otherwise applied to these individuals, the designation of the participant's spouse as beneficiary would have been automatically revoked by their divorce. Had Washington state law been applied to the QRP benefits in question, the former spouse would have been treated as having predeceased the participant. The court ruled that the Washington state law was preempted by ERISA; the ex-wife, as the named beneficiary under the plan, was still entitled to the benefits because nothing in the plan documents said that divorce revoked her rights as named beneficiary.
- In Boggs vs. Boggs,14 the court held that a state's community property law purporting to grant the participant's spouse the right to transfer part of the participant's plan benefits was preempted by ERISA because the right, as in Egelhoff, would require the plan administrator to look beyond the plan documents to determine who was entitled to the benefits.
In Kennedy, there was a conflict between the participant's divorce agreement (under which Liv had waived her rights to the benefits) and the written beneficiary designation form on file with the plan (under which Liv was the named beneficiary). The court viewed the divorce agreement as a valid “federal common law waiver”15 of the benefits by Liv, but held that a federal common law waiver, like a state law revoking a beneficiary designation in case of divorce, would have to give way to the superior rule that the plan administrator must carry out the terms of the plan document. “What goes for inconsistent state law goes for a federal common law of waiver that might obscure a plan administrator's duty to act ‘in accordance with the documents and instruments.’”16
The point of this rule, the court explains in Kennedy, is to avoid forcing “plan administrators to examine numerous external documents purporting to be waivers and draw them into litigation like this over those waivers' meaning and enforceability.”17 The Kennedy court reiterates the importance of “holding the line” “in holding that ERISA preempted state laws that could blur the bright-line requirement to follow plan documents in distributing benefits.”18 ERISA and the court favor “a uniform administrative scheme, [with] a set of standard procedures to guide processing of claims.”19
The court noted that the DuPont plan provided a way for beneficiaries to disclaim benefits and Liv Kennedy did not follow that way.
So, under Kennedy, a QRP should honor a disclaimer only if permitted or required to do so by the plan document.
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The “Governing Law” Provision
Some plan documents, as in Kennedy, explicitly recognize disclaimers. Such a plan is obviously required to honor a disclaimer that satisfies the plan's requirements.
Other plans do not specifically mention disclaimers, but do recite that they are governed by a particular state's laws to the extent not preempted by ERISA. One widely used national prototype 401(k) plan, for example, provides that the administration of the plan is governed by Massachusetts law except to the extent such law is preempted by ERISA.
Under Egelhoff and Boggs, state law is preempted to the extent it would require the plan administrator to do something that is not in accordance with the plan documents. For example, under Massachusetts law, a surviving spouse is entitled to claim a certain share of the deceased spouse's estate. Because ERISA spells out certain spousal death benefits and Massachusetts law spells out different spousal inheritance rights,20 ERISA preempts the Massachusetts rule, and accordingly the plan is not to follow Massachusetts law on this point.
But nothing in ERISA prohibits disclaimers. On the contrary, the Supreme Court has stated in Kennedy that there is a federal common law right of waiver and/or disclaimer and that these rights do not, per se, violate ERISA. And, in fact, federal law favors the right of disclaimer, according to Kennedy. So, it would appear that a plan that is to be administered in accordance with Massachusetts law (except to the extent preempted) is required by the terms of the plan document to honor a disclaimer that complies with Massachusetts law.
Is this approach (piggybacking on the state disclaimer statute) burdensome for plan administrators? Not at all. Plan administrators want to avoid uncertainty, and avoid (as the Kennedy court put it) the need to examine “numerous external documents” to ascertain who's entitled to receive benefits under the plan. To get certainty, it would appear that Kennedy gives the plan's drafter only two ways to go with disclaimers:
- Have the plan document provide that the plan will not honor any disclaimer. This would apparently be permissible under Kennedy, despite the federal policy favoring a right of waiver.
- Permit disclaimers pursuant to a procedure that is spelled out either in the plan documents or under the law of a particular state. This approach is preferable: By tying the plan's administration to a particular state's disclaimer statute, the plan does not have to reinvent the wheel as far as procedures for the disclaimer are concerned and also enjoys the benefit of any state court cases interpreting the applicable statute.
Relying on the Massachusetts law of disclaimers, for example, makes things easy for the plan administrator. The Massachusetts statute requires that a copy of the disclaimer be delivered to the person or entity “having custody or possession of the property”21 (in this case, the trustee of the plan), thus eliminating the concern that the plan administrator would have to examine “external” documents. Also, the statute excuses the holder of the property if the holder distributed the property before receiving the disclaimer, and provides that the property holder has no liability for “any good faith distribution or other disposition made in reliance upon a disclaimer” that has been delivered to it in accordance with Massachusetts General Laws Chapter 191A, Section 5, “if the form of the disclaimer is in accordance with the requirements of” Mass. Gen. Laws Chapter 191A, Section 4.22
By spelling out these reasonable procedures and limitations of liability, the Massachusetts statute functions as part of the plan document, in a manner far preferable to relying on an undefined federal common law waiver whose requirements only the Supreme Court can ascertain and which provides no explicit limitations of liability.
The way to get uncertainty, so dreaded by plan administrators, would be to say nothing in the plan document that could be construed as either banning disclaimers or permitting them pursuant to a particular process. A plan in that situation might (under Kennedy) be subject to the federal common law of waiver in dealing with purported disclaimers by beneficiaries. The problem is that, as with any common law, there is no procedure laid out for carrying out such a waiver (such as a time limit, or any requirements regarding content or delivery of the waiver document). A search of a legal database revealed next to no material on the federal common law of waiver that could operate to guide a puzzled plan administrator.
But Read the Plan
Estate planners cannot assume that the plan administrator of their client's retirement plan will honor a qualified disclaimer. When constructing an estate plan that may require a disclaimer of QRP benefits, the estate planner should read the plan document to see whether it specifically permits or prohibits disclaimers. If the plan is silent, the estate planner may wish to:
- get confirmation of the plan's policy on disclaimers; or
- make the benefits payable to a trust, so that the disclaimer can occur at the trust level without involving the plan administrator; or
- have the client “roll over” the benefits to an IRA, if that is possible, when disclaimers do not pose ERISA problems. (IRAs are not subject to ERISA.)
- Kennedy v. Plan Administrator for DuPont Savings and Investment Plan et. al., 129 S.Ct. 865 (2009). This article is adapted from Chapter 4 (“Inherited Benefits: Advising Executors and Beneficiaries”) of the forthcoming 7th edition of Natalie B. Choate's book Life and Death Planning for Retirement Benefits, (Ataxplan Publications, www.ataxplan.com).
- Employee Retirement Income Security Act of 1974 (ERISA) Section 3(2)(A).
- Internal Revenue Code Section 414(p).
- IRC Section 401(a)(13).
- 29 U.S. Code Section 1056(d)(1).
- Kennedy, supra note 1, 129 S.Ct. at 872.
- IRC Section 2518(b)(4).
- Kennedy, supra note 1, 129 S.Ct. at 872.
- General Counsel Memorandum 39858.
- See, for example, Private Letter Rulings 9016026, 9247026, and 2001-05058.
- 29 U.S.C. Section 1132(a)(1)(B).
- These holdings would appear to “overrule” PLR 8908063, in which the Internal Revenue Service ruled that a plan must conform to a state's slayer statute, and not pay benefits to the person who murdered the participant, even if that person is named as beneficiary under the plan.
- 532 U.S. 141 (2001).
- 520 U.S. 833 (1997).
- Kennedy, supra note 1, 129 S.Ct. at 877.
- Ibid., at 876.
- Ibid., at 875.
- See, for example, Massachusetts General Laws Chapter 191, Section 15.
- Ibid., Chapter 191A, Section 5, third paragraph.
- Ibid., Section 6, first paragraph.
Natalie B. Choate is of counsel with Nutter McClennen & Fish LLP in Boston