Sometimes you think you’ve done everything right and it still doesn’t work out. That can easily be the case when designating Solo 401(k) beneficiaries. The ERISA rules possess a little known application that can play major havoc when it comes to inheritance. If you’re growing your retirement funds with a Solo 401(k), make sure that this aspect of your paperwork is properly addressed.
The Good Intentions of ERISA
ERISA is a piece of government legislation passed in 1974. It laid the groundwork for the modern-day retirement industry allowing for accounts like the IRA and 401(k). (The 401(k) in its current form dates back to legislation from 1981.) In addition to offering tax benefits to incentivize retirement saving, it also had what to say about designating beneficiaries. One of the key points was the protection of the spouse’s interest. In short, an existing spouse is always considered a primary beneficiary. This was done in order to make sure an elderly spouse was not left indigent in the case of their partner’s death. It also helped avoid legal wrangling by establishing a status quo.
The Primacy of a Spouse in a Solo 401(k)
What happens though if you do not want your existing spouse to be the beneficiary of your Solo 401(k)? This often happens in the case of a second marriage. If the account holder has children from a previous marriage, and then remarries later in life, they will often want the entirety of their Solo 401(k) to go to their children. This isn’t necessarily out of spite for the new spouse, but rather because in second marriages there can be a general understanding that the finances will remain separate. However, ERISA doesn’t recognize this understanding. From an ERISA perspective the current spouse will always be considered a primary beneficiary, even if the account holder has designated other beneficiaries on the Solo 401(k) paperwork.
This situation has historically led to intense and emotionally draining legal battles. In one such case in 2011, a question about the 401(k) benefits of Leonard Kidder was taken up by the court. Leonard was an employee of Cajun Industries and was a participant in its 401(k) plan. Initially his wife, Betty Kidder, was named as the sole beneficiary. Subsequently, after her death, he changed the beneficiaries to be his three grown children. After that, Leonard remarried a woman named Beth Bennet. Six weeks after that marriage he passed away.
The adult children automatically assumed they were entitled to their father’s 401(k) finds, especially as they were the only ones listed as beneficiaries. However, Leonard’s new wife made the claim that under ERISA law a spouse always takes precedence in a retirement plan. The court sided with Beth Bennet and awarded her the 401(k) assets.
How To Remove a Spouse as a Beneficiary
If you want to change your spouse from being the beneficiary for your Solo 401(k), they have to agree to the fact. They do so by signing a Spousal Consent and Waiver form. (This form is provided by the Solo 401(k) administrator.) The Spousal Consent and Waiver form will usually contain the following points:
- The spouse consents that the plan benefits should go to the listed beneficiaries.
- The waiver is voluntary and the spouse is under no duress to complete the form.
- The consent is irrevocable.
This form must be filled out in all circumstances, and can only be done so after the couple is married. That means that even if the couple addressed Solo 401(k) benefits in a prenup, the ERISA rule would still hold power and the current wife would be able to collect.
What To Do If a Spouse May Not Want to Sign
Financial discussions before marriage are always sensitive, but they are essential to avoiding trouble down the line. This is especially true in a second marriage. If a Solo 401(k) account holder gets the sense that their future spouse will not be amenable to signing a waiver (and they still wish to pursue the marriage,) there are a number of proactive options available.
- Make conditions in the prenup – As mentioned before, an agreement in a prenup does not override the ERISA rule. However, that doesn’t mean that the prenup can’t serve as a powerful tool. The prenup can state that as soon as the couple is married, the spouse will sign the Spousal Consent and Waiver form. Consequences can be attached to this condition, either in the form of penalties in the failure to sign or as incentives once the signing has occurred.
- Rollover to an IRA Before Marriage – The ERISA spouse rule affects 401(k) plans but it doesn’t affect IRA accounts. This is because IRA accounts are governed by state rules. In many states, an IRA account holder can independently name any beneficiaries they want and that decision will be binding. This is true even though the funds were originally in an ERISA governed account and only subsequently rolled over into an IRA. This ruling was upheld in the 2010 case Charles Schwab & Co. v. Debickero.
One exception to the IRA solution is the fact that there are a few states which have a law called “community property”. This law functions similarly to the ERISA law and awards the spouse half of the retirement benefits. However, there are a lot of exceptions and the details vary from state to state. You would need to speak to a financial expert for the specific state to find out if community property applies to your situation. The states which have some variation of this rule are Alaska, Arizona, California, Idaho, Louisiana, New Mexico, Nevada, Texas, Washington, and Wisconsin.
Moving Forward With a Solo 401(k)
If you currently possess a Solo 401(k) plan and are interested in changing the beneficiaries, please reach out to a Broad specialist. They can provide you with the documentation you need to make a successful change. In the case where a rollover to a Self Directed IRA is advisable, they can help educate you about the next steps in the process. You can schedule a call here.