Back in 1994, David Egelhoff lived in Washington state and worked for the Boeing Company. It was a respectable job with a good pension plan and a life insurance policy. He had been married a couple of times. He had two kids with his previous wife and was just coming out of a divorce with his second wife, Donna Rae Egelhoff.
Two months after David signed the papers to finalize the divorce from Donna, he got in a car crash and died. Both his retirement plan and life insurance policy were awarded solely to him in the divorce decree, but he died intestate (legally unrepresented).
Unfortunately, he never swapped out Donna as his designated beneficiary on his benefit paperwork. The manager of both the plan and the policy, the Employee Retirement Income Security Act (ERISA), paid Donna $46,000, the proceeds from the life insurance policy.
Under Washington state law, David Egelhoff’s children from his previous marriage, Samantha, and David, were his statutory heirs. They wanted to recover their father’s life insurance proceeds, so they sued Donna in state court.
Because the Washington state law conflicted with the federal law, ERISA only recognized the last designated beneficiary which was Donna. So, to resolve the issue, the case was pushed from court to court until it finally ended up in the United States Supreme Court in 2001.
SCOTUS ultimately ruled Donna would keep the money because ERISA’s policy dictates the last known beneficiary receives the proceeds. This reinforced ERISA’s federally controlled standard procedures. They also noted the problem with allowing states to impose their own laws on federal administrations like ERISA creates roadblocks in administering the proceeds from plans and policies.
This ruling only applied to ERISA, which manages benefit plans like 401(K) and 403(B). ERISA does not control individual retirement plans (IRAs). This means if an IRA were in question: Would they be resolved using state law, meaning Egelhoff’s kids would receive the benefit, or would it fall under federal law as well and release the money to Donna as the designated beneficiary?
There is an obvious takeaway from the Egelhoff case—take the time to check or double-check specific accounts, plans, and policies to make sure the designated beneficiaries are correct, and the money will go to the desired people. There should be no question where the money will go when someone passes. And there should be no reason to leave loved ones or a divorced spouse battling it out in courts, building years of animosity and attorney fees.
When someone leaves behind a mess of paperwork with outdated information, cases like these can get complicated. The Egelhoff case is evidence that information can go out of date in two months. A day can be too late when it comes to divorced spouses. There are a couple of things Californians can do to make sure their estate is dispersed according to their wishes.
California Rules for Retirement Plans
So often, the idea of estate planning gets tangled up with the contents and beneficiaries of a will. What many overlook in the process of sorting the affairs of an estate are retirement plans or 401(K). A well-funded 401(K) can be the most valuable asset in an estate. Because of its importance, keeping the beneficiary information updated on all financial assets like life insurance policies and 401(K).
So much of a person’s assets are tied to financial products like these, and often, the designated beneficiaries have not been changed since you opened these accounts years ago. 401(K) or IRAs designations are legally binding and usually take precedence over instructions in a will.
However, if you decide to seek a divorce from your spouse, you may have to divide your 401(k) equally during your division of assets. Depending on when you acquired your retirement plan, your spouse may receive up to half of the value you acquired during your marriage.
California is a 50/50 or no-fault divorce state, operating by fairly dividing a married couple’s combined assets, known as community property. This division of assets also applies to retirement plans and usually causes substantial negotiations during a divorce.
Spouses often receive 50% of the retirement plan’s value, but only on the sum accrued during the marriage. This process manages all classifications of retirement accounts, including:
- Employment-based plans or 401(k)
- Family-owned business plans
- Traditional private employment plans
There are two options when dividing retirement plans, including:
- Both spouses agree one spouse will receive a retirement plan payout of a retirement plan when the other retires.
- Or both spouses can agree to allow one spouse to have sole control over the retirement plan, and the other spouse receives another portion of their community property that equals their share of the retirement plan.
If one of these two options cannot be agreed upon, the court may order the couple to decide by evaluating circumstances. The options can impact people in multiple ways. There is a risk of losing a retirement plan’s future value, or it could have tax implications.
After an agreement is reached, and the retirement assets are split, a Qualified Domestic Relations Order (QDRO) will be needed to facilitate the transfer of the proceeds of the 401(k) into a spouse’s retirement plan. A QDRO is a convenient way to transfer funds while remaining tax-and-penalty-free. It also allows funds from a 401(k) to be rolled into a Roth or traditional IRA,
There may be an urge to withdraw funds from a 401(k) because of concerns about losing large chunks of a retirement plan in an upcoming divorce. Actions like these have consequences. The court may look at this move as taking an advance from future retirement funds. Courts can order the account to be reimbursed, or other assets in the community property could be forfeited.
Depending on the circumstances of the withdrawal, courts may take other actions to balance the division of community property, including:
- Pay a pre-tax
- Pre-penalty valuation of the funds
The best move is to seek advice from a qualified estate planning attorney to help navigate the treacherous waters of divorce and retirement plans.