Overcoming the Boggs dilemma in community property states.

• Author: Rogers, Marjorie A.
• Position: Part 2 - ERISA preemption

EXECUTIVE SUMMARY

* A participant spouse who has reached age 59 1/2 and whose pension plan permits in-service withdrawals may transfer funds from his qualified plan to an IRA to avoid ERISA's preemption of state community property laws.

* Alternatively, the participant spouse can create a promissory note in favor of the nonparticipant spouse in exchange for the latter's community property interest in all or a portion of the plan assets.

* Practitioners should carefully review their state's community property laws before preparing documents to complete the transactions proposed herein.

The Supreme Court's decision in Boggs v. Boggs disallowed the bequest of a nonparticipant spouse's community property interest in her participant spouse's pension plan; in community property states, this decision potentially wastes the applicable exclusion amount (AEA) ($650,000 in 1999) if the nonparticipant spouse dies first with insufficient assets to fully use the AEA. Part I of this article explained the issues; Part II discusses estate planning techniques that may allow the nonparticipant spouse to overcome the limits presented by Boggs.

Part I of this two-part article, in the August issue, explained the Supreme Court's decision in Boggs(20) and the negative consequences that could ensue if a nonparticipant spouse dies first. Part II, below, discusses planning techniques to avoid this result.

Alienation of Pension Plan Benefits

Another issue in planning to avoid the Boggs limitation is the alienation of pension plan benefits under Sec. 401(a) (13) (A); that section bars participants and beneficiaries from assigning, alienating and pledging their interests in qualified plans. As long as the participant spouse is alive, the nonparticipant spouse is neither a participant nor a beneficiary entitled to an interest in the plan. The relinquishment of the nonparticipant spouse's community property interest in the participant spouse's account is actually in accordance with Sec. 401(a)(13)(A), because it increases the participant's right to the account balance. Further, the arrangement does not provide for the payment of plan assets to anyone other than the plan participant, the person protected under Sec. 401(a)(13)(A).

The nonparticipant spouse's sale of his present community property interest in the plan assets is not an alienation or assignment of the plan benefits under Sec. 401(a)(13)(A). The participant has not assigned or alienated the plan benefits by gaining a greater interest in the plan assets. The beneficiary has not alienated or assigned any interest in plan benefits if he has not been changed. Yet, consideration has been given in exchange for the promissory note, because the nonparticipant spouse has surrendered a present ownership in the plan assets.

The nonparticipant spouse could still be the designated beneficiary of the retirement asset, to provide flexibility if the participant dies first. Alternatively, the nonparticipant spouse could agree to allow the participant spouse to change the beneficiary, provided the former is informed of any rights being relinquished (such as the right to the required statutory portion of a qualified joint and survivor annuity).

Examples

The following examples illustrate the merits of issuing a promissory note for a nonparticipant spouse's community property share of a participant spouse's pension:

Example 1--Community property state: X is married to Y; they live in a community property state and each is 50 years old. Their assets include a $350,000 house, $150,000 in miscellaneous assets and a $1,000,000 balance in X's employer's Sec. 401(k) plan. All of X's and Y's assets are...