Beneficiary Provisions and Designations – Plan Now for More Simplicity Later
Outside of death, beneficiary provisions and designations under qualified plans (see ERISA Section 3(8)) tend to receive little attention. Unfortunately, death may spotlight or uncover less desirable provisions and once-hidden ambiguities. With some minor review and planning now, however, you can better prepare for simplicity later.
Disentangle Your Waterfall Provision
In general, a waterfall provision provides instruction for what happens to a benefit when the participant dies before that benefit begins and there is either no beneficiary designation or no designated beneficiary survives the participant. Thus, the waterfall provides an ordering rule for the payment of death benefits, starting with the named beneficiary and only moving on to the next category if the foregoing category does not exist or is inapplicable. As noted below, better waterfall provisions tend to be shorter and involve fewer determinations.
Avoid using waterfalls that create unnecessary burdens. This may occur where decisions must be made about which individuals fall into which categories, and those categories are not complete. For example, a waterfall provision may provide that absent the named beneficiary and the spouse, then the following ordering rule applies: (1) the children (or children of deceased children, by right of representation), (2) the parents, (3) the brothers and sisters (or children of deceased brothers and sisters, by right of representation), and finally, (4) the estate. The difficulty with such a provision, of course, is that the plan administrator must now ensure that it knows who all such individuals are, which can be difficult to verify, not to mention the need to define the foregoing categories to address situations such as adoption or step-siblings.
Consider implementing a waterfall that uses fewer and easier categories. Anecdotally, we have found the following waterfall tends to work best: (1) the named beneficiary, (2) the spouse, and (3) the estate. While no waterfall avoids all issues, this shorter provision generally avoids the thorny determinations that can otherwise occur.
Address Deaths of Beneficiaries
A strong beneficiary provision not only addresses what happens when a participant dies, but also what happens when the beneficiary dies – after the participant does but before receiving benefits. As an example, assume participant Ned dies when his named beneficiary, Kate, also his spouse, still lives. Before benefits are distributed, however, Kate also dies, and the question then becomes whose estate falls next in line. While we believe the better result should be Kate’s estate—Kate would have otherwise received the benefit, so that seems to make better sense than Ned’s estate springing back into play—the best result should be that the plan explicitly says what will happen should that situation arise.
Be Ready for Small Estates and Minor Children
Two sticky situations that may occur with any waterfall provision are those involving small amounts or minor children. In the former, the estate becomes the beneficiary, but with a small account balance. Because the cost of opening an official estate may be prohibitive, many states allow for distribution via small estate affidavits, provided the amount in question does not exceed a dollar threshold, such as $50,000.
In general, these state laws permit one or more persons to file an affidavit, swearing to be the heir(s) of the decedent and affirming entitlement to the plan benefit, and then provide that affidavit to the plan without opening a formal estate. As an added bonus, many state laws provide the plan protection when relying on a small estate affidavit, as if the plan distributed the benefit to a formal estate. When faced with situations involving small account balances and estate distributions, a plan sponsor may consider suggesting the small estate affidavit process to applicable plan claimants.
The second sticky situation involves distributions to minor children. While a plan may try to draft applicable provisions, most states have adopted some version of the Uniform Transfers to Minors Act. Similar to laws for small estate affidavits, these laws allow the plan to distribute benefits to the minor with the benefit of state protection, provided the child’s custodian submits a certification or affidavit on behalf of the minor child acknowledging receipt of the benefit as custodian for that child. Where a plan has knowledge of minor child beneficiaries, suggesting or requiring compliance with the applicable state transfers to minors act should allow for a more timely and safer distribution.
Specify When Determinations Are Made
As a final point, we recommend you review your beneficiary provisions and designation forms to ensure that it’s clear when beneficiary designations are reviewed and determined for approval—either when submitted to the plan sponsor or when the participant dies. The difference in timing can affect who becomes the beneficiary. For instance, Internal Revenue Code Section 401(a)(11) generally requires that if a participant is married at the time of his or her death, the participant’s designation of a beneficiary other than the participant’s spouse may be given effect only if the spouse has provided written consent to the designation.
The question then becomes when is validity of the beneficiary designation (and in particular the spousal consent requirement) reviewed and determined? Consider a situation where a married participant names his mother in his designation but without spousal consent. Sometime later, the participant and spouse divorce, after which the participant dies. Who then becomes the beneficiary? If the designation is reviewed at death, the mother should receive the benefit because the participant was not married then, so no spousal consent was required. If the validity of the designation is reviewed and determined at submission, then it presumably is invalid because spousal consent was not provided, and the plan’s waterfall provision would then apply. While such situations may not occur frequently, careful drafting (and consideration of plan administration) can denote when designations are determined and help avoid headaches down the road.