Dear Friends —

Do you own a life insurance policy? An annuity? How about an IRA? Are you covered by a company retirement plan?

Do you know who the beneficiary is on each of these assets? Are you sure this is the person who should receive this money if something happens to you?

It’s not just a smart practice to review your beneficiary designations every couple of years; it’s essential you do this if you experience any major changes in your life, such as divorce or the birth of a child or grandchild, because it can save your loved ones a lot of unnecessary grief.

I’m reminded of this by a recent decision (April 28, 2005) of the Michigan Court of Appeals. It involved Hetta Moore, the ex-wife of Clarke Moore, who had died.

Clarke and Hetta divorced in 1999. As part of the divorce settlement Hetta agreed — in a document drawn up by her own attorney — that she no longer had a right to any retirement plans or policies owned by Clarke.

Now here’s where it gets a little tricky. As you probably know, federal law trumps state law. If a state says it’s legal to do “X” but federal law says that it is not, it is not legal. Period. It’s how certain states were forced to eliminate racial discrimination in the 1960s even though their own laws said “separate but equal” was okay.

The federal law known as ERISA (Employee Retirement Income Security Act of 1974) governs most company-provided retirement plans including defined benefit plans (a.k.a. “pension” plans) and defined contributions plans such as 401(k)s and profit-sharing plans. ERISA preempts state law when it pertains to who has a right to benefits under an ERISA-governed plan.*

Divorce law is state territory. The federal government, except in limited circumstances, such as those that affect the payment of income taxes, stays out of the divorce arena.

Clarke probably figured he didn’t need to do anything to change the beneficiary designations on his life insurance policy and pension plan — worth a total of $132,000 — because Hetta had waived her rights to these as part of their divorce agreement. He died with her still named as beneficiary on both plans.

Trouble is, the administrator of Clarke’s company-provided life insurance and pension plan didn’t know that Hetta had waived her rights to these benefits! All the administrator had to go by was the paperwork Clarke had filled out years before. Since this still said Hetta was his beneficiary, she got the money.**

As you might expect, this didn’t sit well with Clarke’s heirs. They (technically, Clarke’s “estate”) sued in Michigan state court to get the money back, saying Hetta had relinquished her right to this as part of the divorce settlement.

Hetta’s attorney successfully argued that although Hetta had, in fact, waived her right to these benefits as part of the state-administered divorce proceeding, federal law supercedes state law. Since (federal) ERISA says benefits get paid to whoever is named as the beneficiary on an ERISA plan, Hetta was due the dough.

In other words, even though Michigan law allowed her to say she didn’t have a right to Clarke’s retirement plan benefits, it really didn’t count, i.e. her waiver was invalid!

Clarke’s heirs appealed.

In late April the Michigan Court of Appeals, using far more common sense than the lower court, agreed with Clarke’s estate and ordered Hetta to return the money.

The court acknowledged that ERISA preempts state law, but said this wasn’t the issue in this case.

Essentially, the Appeals Court ruled that although Hetta was “technically” still listed as the beneficiary on Clarke’s plans, she had legally and voluntarily removed herself as part of the state-administered divorce proceeding.

(Note: If you’re contemplating or have gone through divorce, make sure any waivers made by your ex-spouse meet state law. If there had been a glitch in the wording of the agreement signed by Hetta, or if the court found that she signed it under duress, she might have ended up with the money after all.)

In essence, after Hetta legally waived her right to Clarke’s retirement assets back in 1999, these accounts were left with NO beneficiary! Which means that, by law, at Clarke’s death they become the property of his estate and are distributed according to his will (or state law, if there is no will).

Clarke could have saved his heirs the legal expenses and headaches they had to endure to finally end up with the money by simply changing the beneficiary on each of his plans — a simple thing to do, just contact your plan/policy administrator. There’s no mention of how much the estate actually ended up with, but I guarantee it was less than $132,000.

Because Clarke’s retirement assets were left to his “estate,” they had to go through probate. While some states have streamlined their probate processes to make them less costly and less onerous, there is still a delay in getting the money into the hands of those who are entitled to it.

99.9 percent of the time, the absolute worst beneficiary you can have on an insurance policy, retirement plan, annuity, or any other asset that can legally pass by virtue of a beneficiary designation, is your “estate.” Leaving these assets — either directly or by default, as in Clarke’s case — to your estate guarantees they will have to go through probate. This costs money and time.

I strongly recommend you dig out your policies and contact your retirement plan provider to find out who you’ve named as the beneficiary(ies) on your accounts. Is this person(s) still alive? Are you still married to this person? Does your-daughter-the-brain-surgeon really need 50 percent of your IRA or would your son-the-pastor need the money more?

Important stuff. Don’t leave it to the courts to decide!

Hope this helps,

Gail

*IRA-based retirement plans are not covered by ERISA. This includes SEPs (Simplified Employee Pension), SIMPLEs (Savings Incentive Match Plan), 401(k)s that use IRA accounts (these are only available for small businesses), and IRAs themselves, both traditional (tax-deductible) and the Roth variety.

It’s just as important to routinely review your beneficiary designations on these plans as well.

**Pity the poor plan administrator who has no idea a divorce agreement has changed the arrangement and who pays out the money to the person listed on the account! In a number of cases, the retirement plan or life insurance company has been sued for giving the money to the “wrong” person. As Virgina Briggs, Senior Editor of the EBIA Manual for ERISA plan sponsors, points out, “How are they supposed to know” about divorce or other agreements that have been signed by the parties involved?

Indeed.

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