area of employee benefits, we have learned that nothing is simple. Even
beneficiary designation forms can create significant issues.
Employee benefit administrators, 401(k) vendors, recordkeepers and benefits professionals regularly recommend that participants in qualified retirement plans periodically review and update their beneficiary designation forms.
The provisions of all qualified retirement plans provide that if a married participant dies without a beneficiary designated, the death benefit will be paid to the participant’s spouse, unless the spouse consents, in writing, the appointment of an alternate payee. For single participants, benefits are paid to their estate if no beneficiary is designated.
What could be simpler than merely indicating to whom or to what entity a participant wishes their assets to be transferred in the event of death? Unfortunately, numerous issues arise in connection with the simple task of designating a beneficiary.
For example, assume that a single male participant in a qualified retirement plan wishes to designate his two children as the beneficiaries of his benefits. He mails the beneficiary designation form to an employer with a cover letter confirming that he has named his two children as the beneficiaries of his death benefits. After he dies, the benefits administrator reviews the beneficiary designation form and notices, for the first time, that the form is not signed. Can the employer honor the unexecuted beneficiary designation form? Should assets pass to the estate or the designated beneficiaries?
These questions can be challenging for a benefits administrator who has no objective other than to transfer the assets to the correct beneficiary. But who is the correct beneficiary?
To answer this question we must delve into the concept of preemption by ERISA, a federal law. The drafters of ERISA stated that ERISA preempts all state laws relating to employee benefit plans. They dismissed a limited preemption clause in favor of a broader interpretation of ERISA. While the case of an unexecuted beneficiary designation form may seem like a clear preemption winner, courts have had significant difficulties in determining when ERISA preemption will apply, or not, when they conflict with state laws.
By definition, ERISA preempts state law if the law relates to an employee benefit plan. The Supreme Court has interpreted the scope of the phrase “relates to” differently over the past 37 years since the enactment of ERISA.
Under the Supreme Court’s original expansive approach, a law “related to” an employee benefit plan if it had a “connection with or with a reference to such a plan.” However, over the years, the court has further defined when preemption applies and has determined that there are situations where the connection to an employee benefit plan is too tenuous to warrant ERISA preemption. Our benefits administrator is more interested in determining whether the beneficiary designation form should be honored or not. To address this issue, the employer must consider the state doctrine of “substantial compliance.” Under this concept, small irregularities, such as the failure to have a legible signature or to attach a rider to a document, should not prevent the effectiveness of a party’s intent. Courts apply the doctrine of substantial compliance to avoid harsh results caused by overly formalistic procedures that may be required in certain instances.
Once again, the question arises whether the failure to sign a beneficiary designation form results in the benefits being paid to the estate, as provided in an ERISA retirement plan document, or benefits being paid in accordance with a beneficiary designation form that may be saved under state law principles, since the participant substantially complied with his effort to designate a beneficiary, as evidenced in a cover letter stating that he had designated the beneficiaries in an attached form.
As is common in litigation, the Circuit Courts throughout the United States are split as to whether ERISA preemption would require benefits to be paid to the estate, or state law doctrines would allow the beneficiary designation form to be honored.
Consider the Ninth Circuit case of Bankamerica Pension Plan v. McMath. This case involved an employee of a bank who submitted an unsigned beneficiary designation form for a 401(k) plan, naming a beneficiary. After the participant’s death, the original beneficiary and the new beneficiary both claimed entitlement to benefits. In this case, the 401(k) administrator held that the new beneficiary was entitled to the benefits despite the “omission” of a signature. The court held that ERISA preemption did not apply under these facts.
Despite the holding in this particular case, most practitioners would initially conclude that ERISA should preempt state common law principals. Thus, an employee benefits committee will typically deny a request to honor an unexecuted beneficiary designation form, unless the employer is located in California, within the jurisdiction of the Ninth Circuit or a jurisdiction with similar holdings.
Similar to the Ninth Circuit, the Third Circuit (covering New Jersey, Delaware, Pennsylvania and the U.S. Virgin Islands) might hold that ERISA does not preempt state common law with regard to substantial compliance.
In Metro. Life Ins. Co. v. Kubichek, a decedent had changed his beneficiary forms to indicate that his new wife was the beneficiary on a group life insurance policy. He also sent a letter to his employer confirming that his new wife was to be the sole beneficiary for all plans to which he was entitled. However, he did not specifically change the beneficiary information on an optional group life insurance form, leaving his mother as the beneficiary of that policy.
Upon his death, his mother believed she should be the beneficiary of the optional life insurance policy because he had not completed the change of beneficiary form for the optional policy. Conversely his wife argued that there was enough evidence to prove that he had substantially complied with the procedures to make her the beneficiary of the optional policy. The Third Circuit Court of Appeals first noted that the life insurance plan was an ERISA plan. Then the court applied the state law of New Jersey regarding “substantial compliance” and awarded the death benefit to the mother, due to the failure to demonstrate that the decedent had substantially complied with the MetLife change of beneficiary policy. While the Third Circuit Court of Appeals has not explicitly addressed the ERISA preemption issue concerning “substantial compliance” in its opinions, recent District Court cases have applied state law pertaining to substantial compliance in other cases with similar fact patterns.
By contrast, a few Second Circuit District Court cases exist addressing this issue. In general, the Second Circuit has concluded that ERISA preempts state law and thus, following the Fourth Circuit courts, should apply federal common law with regard to substantial compliance.
One case dealing with an unsigned change of beneficiary form was Connecticut v. Patricia A. Mitchell. The decedent in this case had originally signed a beneficiary form for a life insurance policy that designated his estate as the beneficiary of the policy. Faced with a terminal illness, he allegedly decided to change the beneficiary to a close friend. He completed the required form to change the beneficiary and even mailed it in, but did not sign the document.
The court had to determine whether the decedent had substantially complied with the change in beneficiary form to determine the proper beneficiary. The court concluded that ERISA preempted state law on the issue of substantial compliance and therefore, it should apply federal common law, following the Fourth Circuit’s decision in Phoenix Mutual Life Insurance Co. v. Adams.
Whether or not the unexecuted beneficiary designation form in our illustration should be honored will therefore depend upon the relevant Circuit Court for purposes of interpreting an employer’s plan. However, further consider other issues associated with beneficiary designation forms. For example, is the form clearly written to reflect that if two beneficiaries are named as primary beneficiaries, on the death of one primary beneficiary, will the assets be transferred to the heirs of the primary beneficiary or will benefits only be paid to the surviving primary beneficiary? If a beneficiary designation form is not clear, once again litigation may ensue regarding the proper beneficiary for the death benefit. Therefore, human resource professionals are encouraged to periodically review their beneficiary designation forms for clarity.
Another important issue is, who maintains the beneficiary designation forms? Many employers are outsourcing beneficiary designation forms to third-party vendors. Occasionally, third-party vendors cannot locate beneficiary designation forms, even though records reflect that a form was received. Where does liability lie when beneficiary designation forms are lost?
Employers that have outsourced the retention of beneficiary designation forms should carefully consider their service agreements with vendors with regard to retention of documents and potential liability in the event of errors or misplacement of forms.
Lastly, all benefits professionals should encourage employees to update beneficiary designation forms when they have had a change in status, such as marriage, birth of a child and/or divorce. However, it is not unusual for a participant to become divorced and have a QDRO allocating a portion of a participant’s benefit to a former spouse. It also is not unusual for a participant to forget to change his or her beneficiary designation form even after a divorce (for the remainder of their account not subject to the QDRO).
Some practitioners have taken the approach that beneficiary designation forms should automatically become void upon divorce. This approach would have any death benefits paid to an individual’s estate, rather than a former spouse. Whether or not a specific employer or plan administrator agrees or disagrees with the approach, the issue should be considered when plans are amended. In some instances, the simplest approach may be to state that forms are revoked upon divorce, minimizing the amount of litigation between family members.
We realize that this month’s article may have raised more questions than provided answers. Nevertheless, it is food for thought when plan administrators are reviewing their plan documents, outsourcing administrative functions and determining what actions are in the best of interests of plan participants. More importantly, we encourage a higher level of scrutiny of beneficiary designation forms upon receipt, rather than after death.
Palmieri can be reached at firstname.lastname@example.org.
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