Erik Daley, CFA
Beneficiary designations are used in retirement plans to determine who is entitled to benefits upon the death of a participant. In plans covered by ERISA, aside from certain spousal protections, other types of beneficiary designations are generally a matter of plan design.
In December 2012, the Advisory Council on Employee Welfare and Pension Benefit Plans ("ERISA Advisory Council") prepared a report to the United States Secretary of Labor, titled "Current Challenges and Best Practices Concerning Beneficiary Designations in Retirement and Life Insurance Plans." Based in large part on that report ("the DOL report") as well as our own extensive experience working with retirement plan sponsors, we will be breaking down some of the most common problems when dealing with beneficiary designations, and outlining possible solutions to these problems. This guidance is intended to get plan sponsors to think about their plan design and operations related to beneficiary designations in order to get ahead of issues, and assist participants in ensuring their money ends up where it is intended (and not end up where it is not intended).
Issues for plan sponsors to consider when it comes to beneficiary designations are very broad. There is no "one-size fits all" answer when designing a retirement plan to deal with beneficiary designations. The right approach for your plan will be based on a number of facts and circumstances. Listed below are just a few of the issues plan sponsors should consider when administering beneficiary designations.
Participants fail to change beneficiary designations to reflect life events
According to the DOL report, one of the most common and frequently contentious disputes occurs with participants who marry and/or divorce. Participants often forget to update their beneficiary designations to reflect their changed status and in these cases, disputes can arise between the participant's spouse, ex-spouse, children, or other potential beneficiaries such as parents or other siblings.
Lost or stale beneficiary designations may result in benefits not flowing to the intended beneficiary
Initial beneficiary designation elections are likely to remain in effect for long periods of time without participants reviewing or updating them to ensure that the designation reflects their current intentions. Because of the passage of time, participants often forget who they designated as beneficiaries at an earlier date. In some cases, participants may not recall whether they have ever completed a beneficiary designation form.
Never completed or incomplete designations may result in questions as to whom the benefit should be paid under the terms of the plan
Most plans include beneficiary designations as a standard part of the plan enrollment process. While this is the case, some estimates indicate that possibly 40-60 percent of participants actually complete beneficiary designations. According to one provider's numbers, there is wide dispersion among plans, with some plans obtaining beneficiary designations from 100 percent of the participant population, and others achieving less than 50 percent. Some factors in this variation include: (i) plan sponsors rarely require submission of a beneficiary designation as a condition for enrollment or receipt of benefits, and (ii) in the case of a plan that provides for automatic enrollment, participants who have not made an affirmative election to enroll in the plan are unlikely to submit a completed beneficiary designation form.
Additionally, often when participants do submit a beneficiary designation, the form contains inaccuracies or omissions. For example, a submission where beneficiaries are named, but distribution percentages are miscalculated or even completely silent.
Develop an education program to notify participants of the importance of updating their beneficiary designations when there is a life-changing event
Participants unfortunately often have misconceptions about how retirement plan benefits are distributed in the event of death or divorce. For example, many participants believe that having a will or divorce decree is sufficient in order to have assets distributed per their wishes. In fact, a will or a divorce decree will not override a beneficiary designation. The U.S. Supreme Court has reaffirmed the obligation of ERISA plan fiduciaries to pay benefits in accordance with the terms of the plan documents and the beneficiary designation forms maintained by the plan. The failure to follow these procedures can expose the plan to the risk of double payments and potential claims under ERISA.
A sponsor's education program might point out these misconceptions to ensure participants understand how important the beneficiary designation is. Additionally, it would be helpful if plan sponsors reminded participants to consider beneficiary designations in all plans where they may be entitled to benefits (such as plans maintained by former employers). These efforts should emphasize the importance of keeping beneficiary designation(s) updated, making any necessary changes to reflect participants' life changes and intent as to who benefits should be paid under the plan.
Consider adopting a plan provision that automatically revokes a beneficiary designation upon an employee’s divorce
Adopting a plan provision that automatically revokes designations upon divorce requires considerable forethought. Divorces are complex; many divorces occur pro se (without attorney representation) and even so, many divorce attorneys are not familiar with the requirements of obtaining a qualified domestic relations order (QDRO) in order to assign all or a part of a participant's account to a spouse, former spouse, child or other dependent. Automatically revoking a beneficiary designation could potentially conflict with a QDRO, so this may or may not be a good solution for your plan. Additionally, depending on the size of the employer and the participant population, it may be very difficult for an employer to determine whether and when a divorce has occurred.
Consider annual reminders or conducting a more targeted "re-solicitation" campaign
In addition to the often overlooked statement reminders to participants to review their beneficiary designations, plan sponsors and service providers should consider conducting a more targeted "re-solicitation" campaign. Re-solicitation is a more active (versus passive) campaign to encourage participants to review (and update where appropriate) their beneficiary designations.
It is important to note that re-solicitation does not invalidate previously completed beneficiary designations, and general invalidation of seemingly stale designations is generally not recommended. In some cases, participants who submitted an earlier beneficiary designation may not be able to submit a new one. For example, this might occur if a participant becomes incapacitated or if a participant who earlier obtained spousal consent to name an alternate beneficiary is unable to get that consent again.
Similarly, plan sponsors and/or their vendors could consider a mechanism to remind participants whom they have selected as their beneficiary on an annual basis. For example, those with more sophisticated electronic records, selected beneficiary designations (or lack thereof) could actually be listed on the participants’ statements.
Consider reviewing beneficiary designation forms upon submission for accuracy, clarity, and adherence to plan rules
Plan sponsors might consider adding procedures to review beneficiary designation forms as they are submitted to help ensure accuracy (e.g. making sure distribution percentages add up) and completion (e.g. checking to see if the form has required signatures). Additionally, sponsors might consider plan document language to account for certain errors. For example, in the event of a form that contains miscalculated or omitted percentages, the plan will interpret such a designation as a direction to distribute the proceeds equally.
Consider the plan's default mechanism
The plan document should provide for a default mechanism for those participants who fail to submit valid beneficiary designation forms. For example, a plan's default protocol may be structured as follows: (1) spouse; (2) children; (3) parents; and (4) estate. Default provisions will often (but not always) match the participant's intent. However, participants should be educated on the pros and cons of allowing a default protocol to take effect rather than filling out a beneficiary designation form. For example, defaulting assets to a deceased participant's estate can be problematic if such participant's estate is subject to the claims of creditors. Assets defaulted to a participants estate would be subject to creditor claims first, prior to being distributed via the terms of the will or intestate succession - which likely is not the intent of the participant.
While the suggestions above will no doubt take time and money to implement, plan sponsors should be aware that in cases where beneficiary designation disputes occur - they will also be required to spend time, as well as financial and other resources to identify the correct beneficiary in order to fulfill their fiduciary duties. Plan fiduciaries may be required to go so far as to defend lawsuits or even commence interpleader actions to avoid paying benefits to an erroneous beneficiary, as doing so would potentially place a fiduciary in the unfortunate position of having to pay the same benefit twice (once to the mistaken beneficiary and again to the correct beneficiary).
Simply educating participants about the importance of updating and maintaining valid beneficiary designations may help to avoid some of the disputes that could arise and expose plan fiduciaries to unwanted and unnecessary liability.
Information contained herein is provided "as is" for general informational purposes only and is not intended to be completely comprehensive regarding the particular subject matter. While Multnomah Group takes pride in providing accurate and up to date information, we do not represent, guarantee, or provide any warranties (express or implied) regarding the completeness, accuracy, or currency of information or its suitability for any particular purpose. Receipt of information herein does not create an adviser-client relationship between Multnomah Group and you. Neither Multnomah Group nor any of our advisory affiliates provide tax or legal advice or opinions. You should consult with your own tax or legal adviser for advice about your specific situation.