Take-Away: If a retirement plan participant wishes to name an individual who is not their spouse as the beneficiary of their retirement account balance on death, the participant’s spouse must consent (‘waive’) their right to be named as the participant’s retirement plan account beneficiary. However, this spousal ‘waiver’ rule does not apply  to an IRA owner; an IRA owner is free to name anyone as the beneficiary of their IRA without the need to obtain the IRA owner’s spouse’s consent.

Background: Federal law mandates a spousal waiver if someone other than the participant’s spouse is to be the designated beneficiary of a qualified plan account, like a 401(k) account or a profit sharing account or a defined benefit/pension benefit. The Employee Retirement Income Security Act (ERISA) and the Retirement Equity Act (REA) override state law with the goal to protect employee retirement benefits by mandating this form of benefit on the death of the participant.

  • General Rule: Under REA a surviving spouse must receive certain benefits from a qualified plan of a deceased spouse plan participant who dies prior to normal retirement age under the plan. To implement this requirement,  the Tax Code was amended to add IRC 401(a)(11)(A) to require that a surviving spouse receive a qualified preretirement survivor annuity benefit if the participant dies before his/her normal annuity starting date. Additionally the Tax Code requires that if the participant spouse survives his/her annuity starting date the mandated benefit (unless waived) must be paid as a joint and survivor annuity benefit. These required forms of payment are intended to protect the surviving spouse’s interest in the accumulated retirement assets. [An aside: As a general rule state laws create and identifies interests in property, to the exclusion of the federal government. The REA was the first instance where the federal government stepped in to create a federal property interest in a surviving spouse, regardless of what a state might otherwise provide. In short, the federal government created a property interest that did not previously exist with REA.]
  • Waiver: IRC 417(a)(2) provides that a spouse may waive a right to a qualified plan benefit if the spouse’s waiver meets four separate requirements: (i) the waiver must be in writing; (ii) the waiver/election must designate a beneficiary that may not be changed without spousal consent (or the consent of the spouse expressly permits additional beneficiary designations by the participant without any requirement of further consent of the spouse); (iii) the spouse’s consent must acknowledge the election’s effect, i.e. the spouse understands that he/she is giving up federal rights and will not receive any of their deceased spouse’s retirement benefits; and (iv) the spouse’s signature on the waiver must be witnessed by a qualified plan representative or by a notary public.
  • Prenuptial Agreements: The IRS in its Regulations [Treas. Reg. 1.401(a)-20, Q-28 and A-28] and several federal court decisions make it clear that a waiver by the spouse can only be valid if it is signed after the marriage occurs, i.e. when the individual is actually a spouse. Consequently, provisions included in a prenuptial agreement that purport to be a waiver of the federal survivor annuity rights is not valid waiver under IRC 401(a)(11) and 417. This is why most prenuptial agreements contain a provision that requires the parties to the agreement to sign the applicable qualified plan waivers after the parties are married.
  • Practical provisions: Since the need to sign a waiver is about the last thing the parties to the prenuptial agreement want to think about on their honeymoon, I usually prepared the spouse’s waiver form at the time the prenuptial agreement was signed so it was ‘ready to go’ and I added language in the agreement that the spouse agreed to promptly sign the attached waiver after the marriage ceremony. I also put in my computer ‘tickler’ system a reminder 30 days after the marriage of the now-spouse’s need to sign the waiver document so that it would be binding. After a couple of awkward moments trying to enforce these promised waivers once the parties were happily married (and wanted to get as far removed from the awkward process of negotiating a prenuptial agreement), I then started to add other provisions to the prenuptial agreement that altered the promised benefits for the waiving spouse under the prenuptial agreement if that spouse refused to sign the waiver after the marriage, e.g. a reduction of 50% in benefits to be received if that spouse was the surviving spouse and the agreement promised a portion of the deceased spouse’s estate. Finally, to induce the reluctant non-participant spouse to sign the waiver after the marriage, I would name the participant’s children as ‘third-party beneficiaries’ to the prenuptial agreement, which would give the children legal standing to sue their step-parent if he/she refused to sign the waiver and the participant later died. [Observation: Needless to say, the I never got a Christmas card from the nonparticipant spouse when I insisted on these provisions in the prenuptial agreement,  all of which anticipated that the nonparticipant spouse would renege on his/her promise to timely sign the waiver.]
  • IRAs: While an IRA is like a qualified plan account, there is no rule under ERISA (which generally does not apply to IRAs) nor in the Tax Code that imposes an obligation to obtain an IRA owner’s spouse’s consent or waiver to name another individual as beneficiary of the IRA. Although  federal law does not require that a non-owner spouse waive his or her rights in an IRA, some financial institutions that are custodians of the IRA impose this requirement, primarily so as to not get embroiled in disputes as to the entitlement to the IRA account balance when the IRA owner dies. Recall that IRAs are primarily contracts between the IRA custodian and the IRA owner, so arguably the custodian can require the owner’s spouse’s waiver to the designation of others as IRA beneficiaries, even though federal law does not require that consent or waiver, as a condition to serving as the IRA custodian. Whether that requirement is good, or bad, for the custodian’s business is another matter. It is just not required under federal law.

Let the Games Begin!: Assume client has a large 401(k) account. Client plans to retire. Client does not like the investment options provided by client’s employer in this employer-sponsored qualified plan. So client’s  intent is to ‘roll-out’ the balance of his 401(k) account to a ‘roll-over’ IRA where he has a wider selection of investment options for his IRA. Oh, by the way, client is in his second marriage with adult children from a prior marriage.

  • Client remains plan participant: If client leaves his 401(k) account in tact with the qualified plan, client’s second wife can insist that she receive a joint and survivor annuity if client dies while he continues as a plan participant, albeit retired.
  • Client rolls 401(k) account to his IRA: If client transfers his 401(k) account balance to a ‘rollover’ IRA, client is free to name his children from his prior marriage as the designated beneficiaries of client’s IRA. Client does not need to obtain the consent of his wife to name his children as sole beneficiaries of his IRA account; if the retirement funds had remained in the 401(k) account client would have had to obtain his wife’s waiver of her right to remain as a joint-and-survivor beneficiary of the account balance, but not with the IRA.
  • Client misleads wife: Suppose client tells his wife that he intends to name his wife as the beneficiary of his ‘rollover’ IRA, and in fact he actually names her as the sole beneficiary of his IRA, and he begins to receive monthly account statements from his IRA custodian where wife is prominently named as client’s sole IRA beneficiary, a beneficiary form which client eagerly shows to her. Later, client changes his beneficiary designation and he replaces his wife with his children from his prior marriage as the sole IRA beneficiaries. Client conveniently forgets to tell his wife of this subsequent beneficiary change. The big surprise comes on client’s death- a surprise to his widow who was planned to live off of  that IRA for the balance of her lifetime.
  • Elective rights: Nor is client’s wife protected by Michigan’s elective right statute that is intended to prevent a surviving spouse from being completely disinherited. Michigan’s elective rights statute only pertains to client’s probate estate, and not to his assets that pass by virtue of the IRA beneficiary designation, i.e. nonprobate transfers of wealth are not part of the decedent’s estate against which the survivor’s elective rights are calculated, just the probate estate, and the IRA transfer is a nonprobate transfer of wealth.
  • Savvy wife: Suppose that client’s wife was not ‘born yesterday.’ She agrees to his desire to move his 401(k) account balance to a ‘rollover’ IRA, but she requires that he contractually agree, in a postnuptial agreement, to name wife as the sole beneficiary of the IRA for the balance of client’s life. Despite this agreement, client proceeds to name his children as the sole beneficiaries of the IRA. Client dies. The postnuptial agreement will protect wife, so long as a Michigan court finds the postnuptial agreement to be valid and not against public policy, a wild guess these days with our courts. But wife will have to file a lawsuit against client’s children, the named beneficiaries of their father’s IRA, to recover the funds that she was supposed to receive. Telling wife that she has the privilege of filing a lawsuit will not be well received, trust me.
  • Who Gets Stuck Paying the Taxes?: You will recall that while IRAs are not subject to ERISA, IRAs are nonetheless covered, or taxed, under the federal tax code. Clients’ children are entitled under the IRA beneficiary designation to receive the distributions from their father’s IRA- taxable distributions to them. If a Michigan court orders the children to turn over the IRA account balance to wife, consistent with what was intended under the postnuptial agreement, the children will be treated as receiving a taxable distribution from the IRA. While there is no 10% penalty on a premature withdrawal from the inherited IRA, there will be an income tax that has to be paid. Yet the children are ordered to turn over the entire IRA account balance to their step-mother. Client’s children, not their step-mother, will receive the Form 1099-R from the IRA custodian, since under the IRA contract they are the individuals who were entitled under the custodial contract to receive the balance of the IRA on the IRA owner’s death. Consequently, the IRS will look to client’s children for the recognition of this taxable income on their own Form 1040 income tax returns. The transfer of IRA assets from client’s children to their step-mother, as ordered by the Michigan judge, will be treated as a lump sum, taxable distribution to the children (not their step-mother.)  Probably the transfer to the step-mother will not be viewed as a taxable gift by the children as there was no donative intent and they were ordered to do so by the court. But there is no assurance that the IRS will not visit the client’s children someday and suggest that the children may have made a taxable gift of ‘their’ asset to another individual since they were legally entitled under the IRA contract to receive the retirement assets, not their step-mother.
  • Then It Gets Real Ugly: Suppose wife,  the step-mother, does not get along well with her step-children (now there’s a surprise!) Wife is convinced that either client’s children unduly influenced client to change the IRA beneficiary designation, or she accuses them of converting the assets [IRA investments] that they knew she was supposed to receive on client’s death. Wife alleges the common  law tort of conversion, since Michigan has a statute that possibly could award the victim of conversion [wife]  treble damages (just asserting the right to treble damages is a great way to get someone’s attention). Or, more likely is the case, wife claims that her intent all along was to rollover her late husband’s IRA to which she was supposed to be the sole beneficiary, into a rollover IRA account, and since she was not yet 70 ½, she planned on the account continue to grow in a tax deferred environment until that later age, and by only being awarded the balance of client’s IRA account by the Michigan judge, she has been damaged by not having had the opportunity to perform a spousal IRA ‘rollover’ on her husband’s death. Are client’s children exposed to a damage award to their step-mother beyond turning over the IRA balance amount per the judge’s order. Do the children find themselves in a situation where they do not receive any of their father’s IRA assets, yet they have an income tax bill to be paid to the federal and state governments without any assets available to pay that income tax,  and possibly also a judgment for damages against them held by their step-mother?
  • Ethics and Conflicts of Interest Implications: A small additional fact. The IRA custodian of client’s IRA  also serves as a fiduciary to wife/step-mother. Does the IRA custodian-fiduciary have any duty to inform wife of the change in husband’s IRA beneficiary designation? What if client tells the custodian-fiduciary to not tell his wife of his change in IRA beneficiary, yet the custodian has a duty to always act in its ‘other’ client’s best interests? How does the custodian-fiduciary proceed in this situation? Maybe that is why many IRA custodians require the spousal consent on a change in IRA beneficiary when federal law does not require that waiver for IRAs. My final rhetorical question: what if the spouses have exchanged durable powers of attorney and the client signs his wife’s waiver to a change in his IRA beneficiary designation relying on a broadly phrased delegation of authority under their reciprocal durable powers of attorney?

Conclusion: While the hypothetical seems a bit absurd, many of these facts arose in one of the final cases that I was handling while practicing law. The tax complications of the named IRA beneficiaries transferring ‘their’ IRA assets to another individual were the center of that dispute, and there were not a lot of solutions that would ultimately shift the income tax liability to the other individual without creating a windfall to the other individual. As for the scope of the fiduciary duty to ‘tattle’ on a client, maybe it is best to address the ‘duty to inform’ both client spouses at the inception of the relationship.