Traps for the Unwary Avoiding Problems With Employee Benefit Plans in Divorce
| Publication year | 2011 |
| Pages | 24 |
| Citation | Vol. 80 No. 2 Pg. 24 |
Traps for the Unwary: Avoiding Problems with Employee Benefit Plans in Divorce
By Steven P. Smith
Divorce happens. In a recent year, more than 14,000 divorce actions were filed in Kansas alone.[1] In many – in fact, probably most – of those divorce proceedings, one or both spouses were participants in an employee benefit plan that was offered by a current or former employer. Some of them may be entitled to benefits under a pension plan. Some may have had an account balance in a 401 (k) plan. And some may have been insured under a group term life insurance plan.
How these benefits should be divided in a divorce is a matter of state law.[2] The benefits themselves, however, are not subject to state law, at least for the most part. The terms and conditions on which these benefits are being offered are governed by federal law, including provisions of the Internal Revenue Code (the Code) and, for most employers, the Employee Retirement Income Security Act of 1974 (ERISA). If ERISA applies – and it applies to benefits offered by any employer other than governmental employers and certain church or church-related employers – state law will be preempted.
Both the Code and ERISA are complicated statutes. The rules they establish are not always well known and may, at times, be contrary to the reasonable expectations a practitioner might have had based on the practitioner's experience in other areas of the law. For this reason, it is possible that these rules may result in an outcome that practitioners, and their clients, did not expect.
This article is intended to highlight problems that can arise when participants in an employee benefit plan are involved in a divorce and to provide suggestions on how these problems can be avoided.[3]
I. Factors Leading to Problems
Most problems involving 401(k) plans, pension plans, and other ERISA employee benefit plans arise due to one or more of the following factors:
• Not knowing what you are dealing with: The attorneys representing the parties in the divorce may not understand what they are dealing with, from a legal point of view, a factual point of view, or, in some cases, both;
• Not providing clear directions to a plan: The property settlement agreement and/or the proposed "qualified domestic relations order" (QDRO) that has been drafted to reflect that agreement may not provide clear directions as to how the benefit under a plan should be divided;
• Lack of follow through: After a property settlement agreement has been approved by the court and a decree of divorce has been entered, a proposed "domestic relations order" may not be prepared, may be prepared but not be sent to the plan administrator, or may be sent to the plan administrator but not thereafter revised to correct any problems that might have caused the plan administrator to reject the proposed QDRO; and/or
• Failure to update beneficiary designations: After a divorce has been granted, individuals may fail to update their beneficiary designations, with the result that their former spouse may still be named as the beneficiary for their death benefits under a pension plan, their remaining 401(k) account balance, and/or their coverage under a group term life insurance plan, even though the decree of divorce might have provided they were no longer entitled to any rights under any of these plans.
Examples of these problems are not hard to find.
A. Example – An overlooked plan
It sometimes happens that a plan is overlooked. For example, in a Tenth Circuit case from Colorado, the decree of divorce required the ex-husband's pension plan to treat his ex-wife as his "surviving spouse" if he predeceased her, thereby entitling her to the receipt of survivor benefits. A "domestic relations order" was issued and accepted by the plan administrator as a QDRO. Eleven years later, after he died, a problem came to light. His ex-wife discovered that he had been a participant in two separate pension plans, and not just the one plan addressed in the divorce decree and the QDRO.
The oversight was eventually corrected, but not until:
(1) His ex-wife had gone back into state court to obtain a nunc pro tunc order correcting the divorce decree;
(2) A new "domestic relations order" was prepared and sent to the second plan;
(3) A lawsuit was filed in federal court challenging the second plan's refusal to recognize a post-death QDRO; and
(4) An appeal was taken to the Tenth Circuit.
In all, it took an extra five years before the ex-wife received the additional benefits to which she was entitled.[4]
In fairness to the attorneys who represented the parties in the underlying divorce action, it does not appear that any of this was their fault – the oversight was apparently due to bad information provided by the employer – but the case nonetheless points out the importance of trying to gather complete information about all of the plans in which an individual is a participant before a divorce is completed.
B. Example – Out-of-date beneficiary designations
An even more common problem is the failure to update beneficiary designations following a divorce. This has been a frequent cause of litigation, including a case that was decided by the U.S. Supreme Court in 2009.
1. The Kennedy case
In the case that was decided by the U.S. Supreme Court – Kennedy v. Plan Administrator[5] – the husband designated his wife as his beneficiary under a defined contribution plan in 1974. Twenty years later, in 1994, they were divorced. Although the divorce decree stated that the wife was "divested of all right, title, interest, and claim in and to" any benefits under any retirement plans existing by reason of the husband's past, present, or future employment, the husband never updated his beneficiary designation for the plan.
After he died in 2001, his daughter asked the plan administrator for the plan to distribute his benefits to his estate, but, relying on the beneficiary designation form that was on file, the plan administrator paid the entire $400,000 balance to his former wife instead. The estate then filed suit against both the employer and the plan administrator, claiming that the divorce decree amounted to a waiver of the ex-wife's claim to benefits under the defined contribution plan and that the defendants had violated ERISA by paying the benefits to the ex-wife.
The district court entered summary judgment for the estate, but the Fifth Circuit reversed, and the Supreme Court unanimously affirmed the reversal, holding that the provisions of the plan document controlled and that those provisions required benefits to be paid to the person who had been designated by the participant as his beneficiary.
2. A case from Nebraska
In a Nebraska case, a woman was receiving group term life coverage under an ERISA plan sponsored by her employer. She named her two daughters from a prior marriage and her second husband as her beneficiaries for that coverage. He later filed for and received a divorce. Although the divorce decree provided that each party was entitled to the proceeds of "any life insurance policies currently owned by him or her," she never updated her beneficiary designation. After she died four years later, and despite the fact that he had lost contact with her and did not even attend her funeral, her second husband asserted his entitlement to a share of the life insurance proceeds. Her two daughters opposed this claim, arguing that, as a result of the divorce, they were entitled to all of the insurance proceeds. The district court granted summary judgment in their favor. However, on appeal, the Eighth Circuit concluded that the Supreme Court's decision in the Kennedy case required the proceeds to be paid according to the beneficiary designation that was on file with the plan administrator.[6]
II. The Laws Governing Employee Benefit Plans
The first step in avoiding these problems is to understand something about employee benefit plans and the laws that govern them. There are two major sources of law for most employee benefit plans.
• The Internal Revenue Code: An employee benefit plan is subject to a number of different requirements that are found in the Code and in the Treasury Regulations. This is particularly true for retirement plans. These requirements are enforced by the Internal Revenue Service (IRS).
III. ERISA "Employment Benefit Plans"• ERISA: Employee benefit plans are also subject to the requirements of the Employee Retirement Income Security Act of 1974 (ERISA).[7] These requirements apply to all employee benefit plans, with the exception of "governmental plans" and "nonelecting church plans." These requirements are enforced by the Employee Benefits Security Administration (EBSA), which is part of the U.S. Department of Labor (DOL).
ERISA applies to "employee benefit plans" offered by employers to their employees (other than "governmental plans" and "nonelecting church plans"). Under ERISA, there are two types of "employee benefit plans."[8] An "employee pension benefit plan" is a plan that provides income in retirement or beyond the end of the employee's period of covered employment.[9] This includes 401(k) plans and most other types of retirement plans, although it does not include what are known as "nonqualified" plans.[10] An "employee welfare benefit plan" is defined, in relevant part, as "[a]ny plan, fund, or program" that is "established or maintained by an employer" for the purpose of providing benefits in the event of sickness, accident, disability, or death (among other types of benefits) to participants or their beneficiaries, whether those benefits are provided through the purchase of insurance or otherwise.[11] If an employer is providing these types of benefits to...
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