P R O B A T E   &   P R O P E R T Y
September/October 2001
Other articles from this issue
Articles from other issues of Probate and Property


Retirement Benefits Planning Update

Retirement Benefits Planning Update provides information on developments in the field of retirement benefits law. The editors of Probate & Property welcome information and suggestions from readers.

Three Developments

Three recent developments affect discussions of the rights of surviving spouses (or former spouses) of plan participants or IRA account owners in previous Retirement Benefits Planning Update columns.

Death Benefits After Divorce

In Egelhoff v. Egelhoff, 139 Wash. 2d 557 (1999), a plan participant had named his spouse as beneficiary of a life insurance policy and of pension benefits provided by employee benefit plans under ERISA. Two months after the participant and spouse were divorced, the participant died without having changed either beneficiary designation. The Washington State Supreme Court, applying a state statute that provided automatic revocation of the designation of a spouse as the beneficiary of a nonprobate asset upon divorce, held that the divorced spouse was not a beneficiary. On appeal, the U.S. Supreme Court held that the Washington state statute was preempted by ERISA § 514(a), which provides that ERISA “shall supersede any and all state laws insofar as they may now or hereafter relate to any employee benefit plan” covered by ERISA. Egelhoff v. Egelhoff, 121 S. Ct. 1322 (2001). The court ruled that the state statute had an impermissible connection with ERISA plans because it (1) required plan administrators to pay benefits to the beneficiaries chosen by state law rather than the plan documents and (2) interfered with nationally uniform plan administration, requiring administrators to master the laws of 50 states (exacerbated by choice-of-law problems) and to contend with resulting litigation.

As noted in the January/February 2000 column, the federal circuit courts of appeal have been split as to whether (and on what bases) a divorced spouse named as beneficiary is entitled to ERISA plan benefits. Decisions in the Fourth, Fifth, Seventh and Eighth Circuits, based on a federal common law theory that a spouse may waive the right to ERISA benefits by entering into a state law divorce agreement, were not discussed in the Supreme Court’s opinion. Since such a waiver of benefits clearly cannot be ascertained from the plan documents which the Supreme Court concluded were controlling, the prompt change of plan beneficiary designations following divorce may now be the only method of averting an unintended benefit to a divorced spouse.

Planning for the Younger Spouse

Under the minimum required distribution (MRD) rules, a surviving spouse of an IRA account owner who dies before attaining age 70 1/2 has a choice of distribution options not available to other beneficiaries. Under Code § 401(a)(9)(B)(iv)(I), a spouse may, as the sole beneficiary of the decedent’s IRA, defer the commencement of distributions until the end of the calendar year in which the account owner would have attained age 70 1/2 had the account owner survived. In the case of a younger spouse (one who has not attained age 59 1/2), the 10% penalty tax that is assessed on premature distributions does not apply, because of the exception for beneficiaries of a deceased account owner. Code § 72(t)(2)(A)(ii). Under the regulations reproposed on January 11, 2001, MRDs from the deceased account owner’s IRA, when they commence, will be measured by the spouse’s annually recalculated life expectancy through the calendar year of the spouse’s death (and then by the spouse’s remaining years of life expectancy, reduced by one for each year following the year after the spouse’s death). Prop. Reg. § 1.401(a) (9)-5, Q&A 5(c)(2).

Alternatively, a surviving spouse may elect to treat the deceased account owner’s IRA as the spouse’s own IRA or roll the account over to the spouse’s own IRA. Under the reproposed regulations, the spouse may simply redesignate the IRA as spouse’s own account (or indirectly elect such treatment either by failing to take an otherwise required distribution or by making a contribution to the account). Prop. Reg. § 1.408-8, Q&A 5(b). In the event of such an “own IRA” election or a rollover, the spouse, as the account owner, would be subject to the 10% premature distributions tax on pre-age 59 1/2 distributions. However, MRDs from the IRA (determined each year by the applicable distribution period table) need not commence until April 1 of the year following the spouse’s attainment of age 70 1/2. In the calendar year following the spouse’s death (either before or after MRDs commence to the spouse), MRDs may be made over the life expectancy of the spouse’s designated beneficiary. Prop. Reg. § 1.401 (a)(9)-5, Q&A 4 and 5. If the spouse’s designated beneficiary is a child, the distributions required after the spouse’s death will be spread over a much longer period than would be the case if the IRA had remained the original account owner’s account.

The Update column of September/October 1999 describes the IRS position adopted in private letters rulings published in 1994 and 1996 that a surviving spouse’s election to continue to treat the IRA as the deceased account owner’s (evidenced, for ex-ample, by the failure to remit the 10% tax on premature distributions) was irrevocable and foreclosed a future rollover or “own IRA” election. A split account method of having access to funds without penalty tax, in part, and of maximizing deferral, in part, is described in that column. PLR 200110033, however, expressly reverses this “irrevocable choice” position and affirms that a younger surviving spouse who has received pre-age 59 1/2 distributions as a beneficiary of a deceased account owner’s IRA may subsequently elect to treat the IRA as the spouse’s own or roll over the remaining account balance to the spouse’s own IRA without having to remit the 10% penalty tax with respect to prior pre-age 59 1/2 distributions. Although this ruling predates the reproposed regulations, the new regulations are substantially similar to the previously proposed regulations in this respect and now state that the election to treat a deceased individual’s IRA as the spouse’s own account “is permitted to be made at any time after the distribution of the required minimum amount for the calendar year of the individual’s death.” Prop. Reg. § 1.408, Q&A 5(a).

QDRO Interest Not Excluded from Bankruptcy Estate

As discussed in the January/February 2001 column, Bankruptcy Code § 541(c)(2) excludes a debtor’s interest in an ERISA qualified plan from the debtor’s bankruptcy estate as an interest in a trust subject to a restriction on transfer enforceable under applicable nonbankruptcy law. Patterson v. Shumate, 504 U.S. 753 (1992). ERISA § 206(d)(1) states that “[E]ach pension plan shall provide that benefits provided under the plan may not be assigned or alienated.” Is a divorced spouse’s right to plan benefits as an alternate payee under a qualified domestic relations order (QDRO) a benefit provided under the plan that may be excluded from the spouse’s bankruptcy estate?

In In re Hageman, 260 Bankr. 852 (Bankr. S. D. Ohio 2001), the court held that the rationale of Patterson did not apply to exclude a debtor spouse’s interest in an ERISA plan because that interest did not emanate from the ERISA plan itself, but from the QDRO. Citing a 1980 Supreme Court decision predating the 1984 amendment to ERISA that added the QDRO provisions, the court emphasized that the anti-alienation provision of ERISA is intended to protect plan participants. Although the opinion also stresses that the QDRO entitled the spouse to a freely withdrawable lump sum payment without regard to the plan terms, a QDRO cannot provide a form of benefit not available to a plan participant (and the benefit in Patterson was also fully withdrawable by the plan participant). It would not be surprising if, contrary to Hageman, other courts in the future view a divorced spouse’s QDRO interest as a benefit protected by a plan’s anti-alienation provision.

Retirement Benefits Planning Update Editor: Harvey B. Wallace II, Joslyn Keydel & Wallace, LLP, Albert Kahn Building, 9th Floor, 7430 Second Ave., Detroit, MI 48202-2717, wallace@jkwlaw.com.