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. 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 to appointing an alternate payee. For a single participant, benefits are paid to their estate if no beneficiary is designated. What could be simpler that 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 wishes to designate his two children as the beneficiaries of his retirement benefits. The employee mails the beneficiary designation form to his employer with a cover letter confirming that he has named his two children as the beneficiaries. Later, following the employee's death, the benefits administrator notices that the designation form is not signed. Can the employer honor the beneficiary designation form? Should assets pass to the estate or the children? Who is the correct beneficiary?
Answering this question delves into ERISA preemption. 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 in the 37 years since ERISA's enactment. 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.
For the benefits administrator in the example above, when determining whether to honor the unsigned beneficiary designation form 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. Once again, 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 to the beneficiaries noted on the form, payment to the beneficiaries may be "saved" under state law principles, since the participant substantially complied with his effort to designate a beneficiary, as evidenced by his cover letter stating his intentions.
Diverging court opinions
The circuit courts 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.
The 9th U.S. Circuit Court of Appeals case of Bankamerica Pension Plan v. McMath, 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.
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. Despite the holding in this particular case, most practitioners initially would conclude that ERISA should preempt state common law principals. Thus, an employee benefits committee typically will deny a request to honor an unexecuted beneficiary designation form unless the employer is located in California, within the jurisdiction of the 9th Circuit, or a jurisdiction with similar holdings.
In the 3rd Circuit's Metro. Life Ins. Co. v. Kubichek, an employee changed his beneficiary forms to indicate that his new wife was the beneficiary on a group life insurance policy. He also purportedly 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. Upon his death, the employee's mother believed she should be the beneficiary of the optional life insurance policy. Conversely, the man's wife argued that there was enough evidence to prove that her husband had substantially complied with the procedures to change her to the beneficiary.
The 3rd Circuit first noted that the life insurance plan was an ERISA plan. The court then went on to apply 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 employee had substantially complied with the MetLife change of beneficiary policy.
By contrast, the 2nd Circuit has generally concluded that ERISA preempts state law and thus, following the 4th Circuit court, 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 employee in this case originally had signed a beneficiary form for a life insurance policy which 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 employee 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 4th 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 depend upon the circuit court. However, 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. HR professionals are encouraged to periodically review their beneficiary designation forms for clarity.
Another important issue is who maintains the beneficiary designation forms. Many employers outsource beneficiary designation forms to third-party vendors. Occasionally, third-party vendors can't locate beneficiary designation forms, even though records reflect that a form was received. Where does liability lie when beneficiary designation forms are lost? Employers who have outsourced the retention of beneficiary designation forms should carefully consider the service agreement with vendors with regard to potential liability in the event of errors, misplacement of forms and retention of documents.
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