Overcoming the Boggs dilemma in community property states.

• Author: Rogers, Marjorie A.
• Position: Part 1 - ERISA preemption

EXECUTIVE SUMMARY

* In planning to mitigate the limits imposed by Boggs, it is important to distinguish between community property and common law states.

* Under Sec. 2053(c), a plan participant can give a promissory note to his nonparticipant spouse in exchange for a waiver of community property rights in the former's pension plan.

* Sec. 2043(b) should not apply to a promissory note exchanged for a community property interest in a participant's pension plan.

In Boggs v. Boggs, the Supreme Court held that the Employee Retirement Income Security Act of 1974 preempted state law, thus disallowing the bequest of a nonparticipant spouse's community property interest in her participant spouse's pension plan. For spouses living in one of the nine community property states, this decision could spell disaster; if the nonparticipant spouse dies first with insufficient assets to fully use the AEA ($650,000 in 1999), it will be wasted. This two-part article explains an estate planning technique that may allow the nonparticipant spouse to overcome the limits presented by Boggs.

As a result of the Supreme Court's decision in Boggs v. Boggs,(1) many practitioners struggle with how to fully use a nonparticipant spouse's applicable exclusion amount(2) (AEA) when his primary asset is a community property interest in the participant spouse's pension plan. While many estate planning professionals hoped that relief would be provided through the clarification of community property rights and retirement benefits included in the Taxpayer Relief Act of 1997 (TRA '97),(3) this has not proven to be the case.

This two-part article proposes that residents of community property states consider using a promissory note from the participant spouse to the nonparticipant spouse to fully use the latter's AEA. Planning opportunities are discussed in detail; examples are included comparing the options available in community property states to those available in common law states. These strategies are additionally compared to the options available to plan participants who have rolled their retirement funds over into individual retirement accounts (IRAs).

The Boggs Decision

In Boggs, the Supreme Court held that the Employee Retirement Income Security Act of 1974 (ERISA) preempts state (in this case, Louisiana) community property laws to the extent they conflict with ERISA. The case involved a dispute over the ownership of Isaac Boggs' retirement benefits following the death of his first wife, Dorothy, in 1979. Dorothy bequeathed her community property interest in Isaac's undistributed pension plan to the couple's three sons. Following Dorothy's death, Isaac married Sandra. Following Isaac's retirement in 1985, he received various benefits from his employer's retirement plans, including a lump-sum distribution that he rolled over into an IRA, shares of stock from an employee stock ownership plan (ESOP) and a monthly annuity payment.

Isaac died in 1989; a dispute ensued over the ownership of his retirement benefits. The sons claimed that Dorothy had transferred a portion of her community property interest in Isaac's undistributed pension plan benefits to them, under Louisiana law. Sandra disputed the validity of that transfer, arguing that the ERISA preempted the sons' claim.

The Supreme Court was faced with two issues. First, could Dorothy, Isaac's first wife, make a testamentary transfer of her community property interest in Isaac's qualified joint and survivor annuity (QJSA)? The Court held that to the extent Louisiana law provided the sons with a right to a portion of Sandra Boggs' ERISA Section 1055 survivor's annuity, it was preempted. The Court further stated that the purpose of the QJSA provisions is to ensure a stream of income to surviving spouses; ERISA's solicitude for the economic security of surviving spouses would be undermined by allowing a predeceased spouse's heirs and legatees to have a community property interest in the survivor's annuity.

Second, the Court considered whether Dorothy could make a testamentary transfer of (1) her community property interest in undistributed monthly annuity payments, (2) an IRA and (3) ESOP stock. In addressing this issue, the Court described ERISA'S primary purpose as protecting plan participants and beneficiaries. Only in very narrow circumstances (e.g., the issuance of a qualified domestic relations order (QDRO)) is beneficiary status conferred on a nonparticipant spouse or dependent. Because Dorothy's sons were not plan participants or beneficiaries, ERISA did not permit them to share in Isaac's retirement benefits.

This position is further supported by the pension plan anti-alienation provisions. Under ERISA Section 1056(d)(1), each pension plan must provide that benefits under the plan may not be assigned or alienated. Thus, the Court concluded that, because the sons' only claim to the assets was through an impermissible alienation or assignment of Dorothy's benefits as a nonvested beneficiary, they had no interest in the retirement assets.

In understanding the effect of Boggs, it is important to realize both what the Court did and did not say. The Court did not state that assets in an ERISA-governed...