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More Problems with Beneficiary Designations — Usually Beneficiary Designations Take Precedence Over Your Estate Planning Documents, But Sometimes They Don’t

Note: This article is Part 3 in a series on the Problems with Beneficiary Designations. Links for the prior two articles are below and at the bottom of this article.

Please click here to read Part 1 and please click here to read Part 2.

 Q. My friend, who is going through a divorce, is convinced that if he updates his estate planning documents, he can leave his beneficiary designations alone, and once he removes his ex-wife from his estate planning documents, then she will be removed from everything. I am pretty sure that in his situation, he should update both the estate planning documents and the beneficiary designations, because if she is still on the beneficiary forms, everything will still go to her. Am I correct, and if so, how can I convince him? Thanks for your help!

A. Your friend may be confused because there is a lot of confusing law in this area, and state law differs from federal law.

Between 2007 and 2009, the Supreme Court heard a deceased man’s daughter argue that she, not his long-divorced wife, should get his retirement plan funds pursuant to federal law. That case was Kennedy v. Plan Administrator for DuPont Savings and Investment Plan.

Even though state law said that the divorce terminated beneficiary designations, and even though the ex-wife had specifically waived her claim to the funds during the divorce, the US Circuit Court of Appeals for the Fifth Circuit on August 15, 2007, and the US Supreme Court in 2009, ruled unanimously that because the beneficiary form was never changed to remove the ex-wife as sole beneficiary, she was entitled to the funds as the named beneficiary pursuant to federal law, and the daughter got nothing.

This situation described is the classic worst-case scenario where you get divorced, your ex-spouse is named as beneficiary, and you never change the form. The man in that case could have easily updated his beneficiary designations and estate planning documents to leave everything to his daughter, but he didn’t think he had to, and instead his daughter had to suffer with these very unintended consequences, and the former spouse got a very unexpected windfall.

Conflict Between State and Federal Law

For legal matters governed by federal law, as with the retirement plan described above, when there is a conflict between federal and state law, federal law generally wins. Many, if not most, retirement plans (and some other types of plans and policies) are covered by the Employee Retirement Income Security Act (ERISA), which has very specific laws regarding beneficiary designations, including the fact that a state decree of divorce does not automatically revoke a beneficiary designation.

Understanding ERISA

ERISA was established by the federal government in 1974 and, as mentioned above, has very strict regulations as to beneficiary designations.

Plans that fall under the rules of ERISA include defined-benefit pension plans and defined-contribution pension plans, including 401(k) plans, 403(b) plans, employee stock ownership plans (ESOPs), and profit-sharing plans. ERISA even goes beyond retirement plans, in that it also covers certain private-sector health plans, including health maintenance organization (HMO) plans, flexible spending accounts (FSAs), some disability insurance, and some life insurance.

State Law Does Not Control All Beneficiary Designations After Divorce

Prior to 2007, most states had laws stating that a divorce automatically terminated all beneficiary designations naming the former spouse, and most attorneys assumed these laws applied to federal pension plans. State legislatures had to scramble after the 2007 Fifth Circuit ruling in the Kennedy case to update their laws. For example, Virginia changed its law in 2007, and again in 2012, so that it now reads as follows (the emphasized sections below in italics were added by me):

“Virginia Code Section 20-111.1 Revocation of death benefits by divorce or annulment.

Except as otherwise provided under federal law or law of this Commonwealth, upon the entry of a decree of annulment or divorce from the bond of matrimony on and after July 1, 1993, any revocable beneficiary designation contained in a then existing written contract owned by one party that provides for the payment of any death benefit to the other party is revoked.

. . .

Every decree of annulment or divorce from the bond of matrimony entered on or after July 1, 2012, shall contain the following notice in conspicuous, bold print:

Beneficiary designations for any death benefit, as defined in subsection B of § 20-111.1 of the Code of Virginia, made payable to a former spouse may or may not be automatically revoked by operation of law upon the entry of a final decree of annulment or divorce. If a party intends to revoke any beneficiary designation made payable to a former spouse following the annulment or divorce, the party is responsible for following any and all instructions to change such beneficiary designation given by the provider of the death benefit. Otherwise, existing beneficiary designations may remain in full force and effect after the entry of a final decree of annulment or divorce.”

Similar changes were made in other states.

What if Your Estate Planning Documents and Beneficiary Designations Contradict Each Other?

Many people mistakenly think that once their initial estate planning documents are in order or their beneficiary designations are made, they’re all set — but that’s certainly not the case. There are many people who have prior spouses or deceased relatives still named as a beneficiary on a retirement account at a former employer, on a life insurance policy purchased long ago, or on their estate planning documents. What they don’t realize is that when you have major life-changing events such as a birth, marriage, death, or divorce, it’s important to update both your estate planning documents and your beneficiary designations. But what happens if your beneficiaries and your estate planning documents contradict each other? Which document takes precedent – the estate planning documents or the beneficiary designations?

Beneficiary Designations Generally Take Precedence Over Estate Planning Documents

The beneficiary designations you put in place for assets such as life insurance, IRAs and other retirement plans, bank accounts, annuities, brokerage accounts, etc. take precedence over any other form of legal documentation, including your Last Will and Testament or living trust. It doesn’t matter which document is more recent; a beneficiary designation, sometimes called a transfer on death or pay on death designation, will almost always hold authority, making it incredibly important to review and change these beneficiary designations as appropriate, which for most people means creating a living trust as part of a comprehensive estate plan and naming their trust as the beneficiary on all of their accounts. That way you will never again have to change your beneficiary designations. If you want to change your estate plan, you just change your trust, keeping all of your wishes consolidated in one document, the trust.

When Should You Make Changes to Your Estate Planning Documents and Beneficiaries?

If you don’t have a trust, then your will and your beneficiary designations should be updated based on life events, including births, deaths, marriages, divorces, or other changes in family dynamics, as well as name/address changes for your loved ones. Failing to update these designations can result in your assets being lost to the over $100 billion in unclaimed property, as explained in Part 1 of this series, or being distributed to someone you didn’t intend. These are the instances where you should update your documents. I will indicate whether you should update estate planning (EP) docs, beneficiary designations, or both (and yes, this is all needlessly complicated, and this needless complexity is generally avoided with a trust):

  1. Family changes (Both): Events such as marriage, divorce, death, birth, or adoption may affect how your estate will be distributed, who should act as guardian for your dependents, and who should be named as executor or personal representative of your estate. While updating your estate planning documents and designating new beneficiaries, you may want to change your name to what it was before you were married (or a new married name) or take other measures to provide for your loved ones and protect the legacy you hope to leave them someday. Beneficiary forms should also be examined after marriage or divorce of the account holder and any time there is a family birth or death, especially if a beneficiary dies.
  2. Relocating to a new state (EP docs): Laws among the states vary. Moving to a new state or purchasing property in another state can affect estate plans and how property in that new state will be taxed or distributed.
  3. Your beneficiaries or fiduciaries have issues that concern you (Both): Do your beneficiaries or fiduciaries have substance abuse problems or maybe live above their means or lack ambition? Rather than leaving assets directly to someone that concerns you, you can establish a trust for his or her benefit and instruct the trustee to distribute assets only if the person meets certain conditions. For example:
      1. Enrollment in a treatment program;
      2. Graduating college or graduate school;
      3. Holding down a steady job.

    With this “incentive” approach, you retain some control over how your legacy will be used. How much control you wish to exercise is up to you.

  1. Changes in your estate’s value (Both, but especially beneficiary designations): When you first did your estate planning or chose to name beneficiaries for certain accounts, you based your decision on how much money was in each account at that specific time. Over time, the value may be significantly larger because of good investment decisions, or the value may be much lower because of the catastrophic expenses of paying for long-term care. Because of the continual fluctuation in the amount of your assets in each of your accounts, your beneficiary designations may no longer reflect how you would truly like to divide your assets. This also applies if you made the mistake of listing specific accounts to go to specific people in your Last Will and Testament, something that should almost should never be done. Rather, the better way to distribute assets is generally through a trust, naming percentages of your total assets to go to specific people.
  2. Tax law changes (EP docs): Federal and state tax laws change frequently, so you will want to be aware of any updates that affect you. An outdated estate plan may fail to take advantage of strategies that will minimize taxes.
  3. Your health care agent is no longer healthy (EP docs): What if the person you designated as your health care agent is no longer the person you trust to make critical decisions that can impact the medical treatment you receive? Your agent may no longer be up to the task, and you may need to consider alternatives.
  4. Changing your executor (EP docs): Your executor is the person you designate in your Last Will and Testament to carry out the wishes you express in your will and to navigate the complex, time-consuming, and expensive process of probate. Often, people name a relative or close friend to assume this important role. Ask yourself whether the executor you named:
    1. Still has the ability to fulfill these complex responsibilities;
    2. Has suffered a decline in health over the years; or
    3. Still wants to serve as your executor or would rather pass the role to somebody else.
  5. You changed your mind (Both): Another obvious time to change beneficiaries or update your estate planning documents is if you change your mind about someone or something.
  6. You made a mistake (Both): Perhaps you made an error that you want to fix. Naming a minor child or other person incapable of managing funds is one possible mistake. Giving money to a high earner who is then pushed into a still higher tax bracket could be another.

For other instances where you should consider making updates to estate planning documents, in particular, please read my article on the subject here. Remember that if you choose to not have a trust, you need to make sure that your will and your beneficiary designations don’t contradict each other and are consistent throughout your estate planning documents and beneficiary designations, and that both are updated accordingly.

How to Check and Change Beneficiaries

It is prudent to periodically, every three to five years, check your estate plan and beneficiary designations and see if anything should change.

Beneficiaries for some accounts can be conveniently checked and changed online. For others, account holders need to request the necessary document from the plan administrator or custodian.

Remember, when it comes to beneficiaries, in addition to IRAs of the traditional, Roth, SIMPLE and SEP varieties, beneficiaries should be checked on 401(k) plans, 403(b) and deferred-compensation employer plans, life insurance policies, 529 education accounts and any bank or other financial accounts that have a Transfer on Death or Pay on Death beneficiary named.

For estate planning documents, even if no changes are necessary, you should regularly, at least every three to five years, sign updated Powers of Attorney. Some financial institutions won’t accept a Power of Attorney more than a year old or more than three years old. Similarly, the older an Advance Medical Directive is, the less likely it is that it will be honored by a doctor or hospital.

Don’t Let Too Much Time Pass Between Reviews of Your Estate Plan or Beneficiary Designations

Again, every three to five years, check your estate plan and beneficiary designations and see if anything should change. Or, if any of the instances mentioned above happen to you, or if you haven’t updated your estate plan or beneficiaries in the last few years, the time to do so is now. Call the Farr Law Firm and be sure to ask about our Lifetime Protection Plan, which ensures that your estate planning documents are properly reviewed and updated as needed, so that they will have maximum effect at law.

Plan in Advance for Yourself and Your Loved Ones

Here at the Farr Law Firm, we have strategies to help all types of people plan for themselves and their loved ones. By planning in advance, each person can retain the assets it has taken a lifetime to accumulate and the peace of mind that their family’s needs will be adequately and properly addressed. If you or members of your family have not done Incapacity Planning, Estate Planning, or Long-term Care Planning, or if a loved one is beginning to need more care than you can handle, please contact us as soon as possible to make an appointment:

Northern Virginia Estate Planning: 703-691-1888
Fredericksburg, VA Estate Planning: 540-479-1435
Rockville, MD Estate Planning: 301-519-8041
Washington, DC Estate Planning: 202-587-2797

Note: This article is Part 3 in a series on the Problems with Beneficiary Designations. Links for the prior two articles are here:

Please click here to read Part 1, and please click here to read Part 2.

 

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About Evan H Farr, CELA, CAP

Evan H. Farr is a 4-time Best-Selling author in the field of Elder Law and Estate Planning. In addition to being one of approximately 500 Certified Elder Law Attorneys in the Country, Evan is one of approximately 100 members of the Council of Advanced Practitioners of the National Academy of Elder Law Attorneys and is a Charter Member of the Academy of Special Needs Planners.

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