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  • Writer's pictureJames McGlynn CFA, RICP

401k Beneficiary Designations are Unique

He Gets, She Gets

James McGlynn | December 15, 2020

IF YOU DESIGNATE beneficiaries for your retirement accounts, that’s usually a surefire way to pass those assets directly to your desired heirs without going through probate—but not always.

Because those beneficiary designations are so important, you should verify your choices every year in case there’s a change due to, say, marriage, birth, divorce or death. Especially marriage and divorce. Which brings me to a crucial issue: When dealing with IRA and 401(k) beneficiary designations, there’s a key difference when it comes to your spouse.

In general, a spouse who hasn’t been named beneficiary of an IRA isn’t entitled to inherit it. Unlike 401(k) plans, IRAs aren’t governed by ERISA—the Employee Retirement Income Security Act—so these accounts don’t have the same protections for spouses. You’re free to name whoever you wish as your IRA beneficiary, even if you’re married, provided you don’t live in a community property state. Indeed, IRAs are excluded from ERISA coverage, even if the funds originated in a 401(k).

By contrast, under ERISA, if the owner of a 401(k) account is married when he or she dies, his or her spouse is automatically entitled to receive money, regardless of what the beneficiary designation says. The exact percentage seems to be a matter of some disagreement—some lawyers say 50%, while others put it at 100%. If there’s no beneficiary listed, the spouse is entitled to 100% of the account.

The spouse can sign a waiver, giving up his or her claim to the account, but only if the spouse is at least 35 years of age. It isn’t enough just to name someone else on the beneficiary form that your employer gives you. The waiver must be filled out, with the spouse consenting to the participant’s choice of beneficiary. If your spouse signs the waiver, which should be provided by the firm that administers your 401(k), a plan representative or a notary public must act as a witness. Why all this bother? Congress wanted to make sure surviving spouses weren’t shortchanged.

Beneficiary designations for 401(k)s become particularly tricky with divorces and remarriages. The right of the surviving spouse is triggered, regardless of when the assets were amassed or how long the couple has been married. That said, there’s a potential exception: Plans can include a one-year marriage rule, whereby a surviving spouse must have been married to the plan participant for at least a year before he or she has a right to 401(k) assets. But not all plans have adopted this provision.

If your former spouse gave up any claim to retirement assets in a divorce, make sure your beneficiary designation form is modified to reflect that change. If not, after your death, the plan administrator will hand over the money to the designated beneficiary—which will be your ex.

Often, the 401(k) owner will change his or her beneficiary designation upon divorce and name the children as the beneficiaries. If the owner later remarries, part or all of the 401(k) assets (again, the exact percentage is a matter of disagreement) will still go to the new spouse, instead of the children, even if the new spouse is not added as a beneficiary—unless, that is, the new spouse signs a waiver.

Keep in mind that a prenuptial agreement can’t take the place of a waiver. Instead, the law specifies that the spouse must sign the waiver. This can be tricky, because such a waiver can be signed only after a couple is married, at which point the spouse has already acquired the right to be a beneficiary of the 401(k).

Planning to remarry? If you want someone else to benefit from your 401(k) assets, such as the children from an earlier marriage, it’s prudent to roll over your 401(k) to an IRA account before you remarry. That should be easy enough if you have a 401(k) at an old employer, but you likely won’t have that option with your current employer’s plan—unless you’re age 59½ or older.

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