7 Ways to Fix Wrong or Missing Beneficiary Designations
Contributor Natalie Choate explains what to do when a decedent names the wrong (or no) beneficiary on retirement accounts.
John Doe has died, leaving a substantial retirement account. Unfortunately, he never named a beneficiary for the account (or he named the “wrong” beneficiary). You are advising his survivors--his family, executor, and/or trustee. What are their options for fixing a defective (or missing) beneficiary designation?
Here’s a menu of seven cleanup options for these situations. Depending on exactly what the problem is, the survivors may be able to use one (or two, or none) of these to fix it.
Check the Default (or ERISA-Mandated) Beneficiary
If there is no beneficiary designation on file with the plan administrator or IRA provider, check the “default beneficiary” provisions in the plan or IRA documents. All qualified employer plans are required under ERISA to make all (or part, depending on the type of plan) of the employee’s death benefit payable to the employee’s surviving spouse if they have been married at least a year. Many plans make the entire death benefit payable to the surviving spouse even when not required by federal law. Thus, if John Doe was married, there’s a chance the benefits are payable to his wife even though he did not fill out a beneficiary form (or in some cases, even if he did fill out such a form and named someone other than his spouse without obtaining her consent).
Most IRAs specify that the decedent’s estate is the default beneficiary, but some name the spouse if living. Since under such an IRA these individuals would be beneficiaries designated “by the plan,” they would be considered “designated beneficiaries” entitled to the life expectancy payout (or rollover for the spouse).
Spousal Rollover Through an Estate or Trust
Suppose the benefits are unquestionably payable to John Doe’s estate--either as default beneficiary under the plan/IRA documents, or because John Doe actually named “my estate” as his beneficiary. If the surviving spouse is the sole or residuary beneficiary of the estate, so the benefits will pass through the estate to her as a matter of right, she is allowed under long-established IRS policy, to roll over the account to her own IRA. Unlike with “required minimum distributions,” where the IRS does not allow “looking through” the estate to find individual beneficiaries, the IRS is much more liberal regarding the spousal rollover. The IRS allows the rollover whenever the spouse has the right to have the benefits, even if that right comes through an estate.
Similarly with a trust, if retirement benefits are payable to a trust, but the surviving spouse has the right as beneficiary and/or trustee to cause those benefits to be paid to her, the IRS has permitted the spouse to roll over the benefits.
Spousal Share of Estate
In some states, the surviving spouse is entitled to claim a share of the decedent’s estate and even specify which assets will be used to fund her share. At least one surviving spouse used such a law to claim the decedent’s IRA as part of her share and roll it over to her own IRA.
“Removing” a Beneficiary by September 30
In some cases, paying off one beneficiary before the “beneficiary finalization date” (Sept. 30 of the year after the year of the participant’s death) may produce a better result for the other beneficiaries. For example, suppose John Doe left his IRA to his trust. The trust is entirely for the benefit of his young children--except for a $10,000 bequest that is to be paid to a charity upon his death. That bequest could cause the trust to “flunk” the IRS’s minimum distribution trust rules because it means the trust does not have “all individual beneficiaries.” If the charity’s bequest is distributed to it prior to the beneficiary finalization date, the charity is no longer a countable beneficiary, and the trust will be deemed to have only individual beneficiaries.
Contesting the Documents
See if there is a way to invalidate an undesirable beneficiary designation--if invalidating the decedent’s final beneficiary designation would cause a more desirable outcome to prevail. In one ruling, the beneficiary form had actually been filled out by the financial advisor, not the IRA owner himself, and that was not in compliance with the plan’s own rules. The form was ruled invalid. In more extreme cases, beneficiary designations have been invalidated due to undue influence.
In one case, the decedent left his IRA in trust for his wife. A will contest (brought by an omitted child) resulted in a family settlement under which the wife wound up with the IRA paid to her outright. The IRS ruled she could roll the IRA over to her own IRA because the settlement represented a reasonable settlement of a bona fide dispute.
Reforming the Documents
What if the family and the trustee get together and revise the beneficiary designation and/or trust instrument to say what they think it should have said to provide the most tax-effective estate plan, and the local probate court issues a decree confirming the reformation? Unfortunately, the IRS has stated that it will not recognize post-death reformations for minimum distribution purposes. The IRS, not being born yesterday, knows how easy it is to get the court to go along with a family settlement that nobody objects to. Unless there is a clear “traditional” case for reformation (such as undue influence or scrivener’s error), there’s not much hope for this route.
A beneficiary can “disclaim” as IRA beneficiary. If all the rules are complied with, the effect is to allow the benefits to pass directly to the next beneficiary in line.
For example, a disclaimer by John Doe’s primary beneficiary would normally allow the benefits to pass directly to John Doe’s contingent beneficiary. Disclaimer can be extremely helpful when two spouses die within a short period of time. If the surviving spouse was named as the first decedent’s primary beneficiary, but did not roll over or otherwise take any steps regarding that inherited IRA prior to her own death; and if the couple’s children are named as contingent beneficiary, a qualified disclaimer by the surviving spouse’s executor should cause the IRA to pass directly to the contingent beneficiaries, resulting in a longer life expectancy payout.
Where to read more: Chapter 4 of the author’s book Life and Death Planning for Retirement Benefits (8th ed. 2019) discusses disclaimers and other cleanup strategies. See Chapter 3 regarding the spousal rollover through a trust or estate.
Natalie Choate is an estate planning lawyer in Boston with Nutter McClennen & Fish LLP. Her practice is limited to consulting regarding retirement benefits. The new 2019 edition of Choate's best-selling book, Life and Death Planning for Retirement Benefits, is now available through her website, www.ataxplan.com, where you can also see her speaking schedule and submit questions for this column. The views expressed in this article may or may not reflect the views of Morningstar.