ERISA savings plans: A cautionary tale for clients

One of the most important services an advisor can provide to their clients — and their eventual heirs — is also one of the simplest: making sure they name a beneficiary on the beneficiary designation form of their company retirement account. Failure to do so has caused much misery and protracted legal action between family members after a client dies.

As an example, just see this recent court case. It's one in a long line of cautionary tales illustrating what can happen when an employee neglects this task.

In a case decided in May, Kinder Morgan Incorporated v. Joanne Crout, the Fifth Circuit Court of Appeals ruled that a deceased participant’s surviving spouse — and not his children — was entitled to his ERISA retirement plan benefits because the participant never named a beneficiary. The spouse was therefore the proper beneficiary under the terms of the plan and as required by ERISA.

Here’s the background: Danny Lee Crout was an employee of Kinder Morgan, a large energy infrastructure company, and participated in its ERISA-governed savings plan. Crout died in 2016, leaving a surviving spouse, Joanne Crout, and three children.

The plan specified that, in the absence of a beneficiary designation, the participant’s benefit would be paid in the following order of priority:

1. Surviving spouse, if any;
2. Surviving children, if any;
3. Surviving parents, if any; and
4. The participant’s estate

After Crout’s death, the three children and Joanne Crout made claims to his benefit.

David Paul Morris/Bloomberg

The children argued that their father had designated them as beneficiaries in a prior retirement plan that had merged into the Kinder Morgan plan. They also contended that the Crout marriage was invalid and, finally, claimed that the beneficiary issue should be decided by a state probate court and not by the federal court.

Joanne Crout argued that her husband had made no beneficiary designation and therefore she was entitled to the funds. Spoiler alert: She won. The federal court denied the children’s arguments and ruled that Mrs. Crout was the proper beneficiary.

The children then appealed to the Fifth Circuit Court of Appeals, covering Louisiana, Mississippi and Texas. That court, however, agreed with the lower federal court, ruling that Crout’s benefit should be paid to his wife because he had not designated a plan beneficiary. The court found that the Crout children had not offered any evidence that the prior retirement plan — the one in which Crout named his children as beneficiaries — had merged into the Kinder Morgan plan and, further, that they also failed to produce any evidence that the Crout marriage was invalid.

Advisor takeaways

Avoidable litigation
Crout died in 2016, the lower court decision was not decided until 2018 and the Fifth Circuit appeal was not decided until 2020. Four years of expensive litigation could have been easily avoided had Crout simply filled out what is typically a one-page form.

Spousal consent (usually) needed
Once the court found Crout had not made a beneficiary designation, its decision was easy. ERISA retirement plans are required to pay benefits upon a married participant’s death to the surviving spouse, unless the spouse has consented in writing to another beneficiary.

By contrast, except in certain community property states, married IRA account owners are free to designate any beneficiary they want without spousal consent.

Married participants in certain ERISA plans are also required to obtain a spousal waiver to have their benefit paid in a lump-sum distribution, or in an annuity with a non-spouse beneficiary. However, this rule does not apply to 401(k) and 403(b) plans unless the plan offers an annuity as an optional form of payment. Since most 401(k) plans offer only a lump-sum form of payment, they are usually exempt from this spousal consent requirement. However, the rules always apply to ERISA-covered defined benefit pension plans.

The upshot is that if a married 401(k) participant wishes not to leave his or her benefit to a spouse, they can usually (except in certain community property states) accomplish this by rolling over their 401(k) lump sum distribution to an IRA. However, keep in mind that 401(k) plans impose restrictions on distributions.

Plan benefits and IRAs are generally not probate assets
This case also drives home the point that company plan funds are typically not probate assets. Plan benefits normally bypass probate and can be paid to the beneficiary designated by the plan participant — subject to the spousal consent rules for married participants in ERISA plans. The terms of the participant’s will (or state law if there is no will) must yield to the beneficiary designation form and, if applicable, ERISA.

Although IRAs are not governed by ERISA, they are also generally not subject to probate and the IRA beneficiary is normally determined by the beneficiary designation form. However, retirement assets must pass through probate if the plan participant or IRA owner has named his estate as beneficiary or fails to name a beneficiary and the plan document or custodial agreement does not specify a default beneficiary.

New for 2020 — temporary virtual consent!
Spousal consent usually must be witnessed personally by a notary public or a plan representative. But in light of the coronavirus pandemic, the IRS has waived this requirement for any spousal consent made in 2020. IRS Notice 2020-42, issued in June, says elections witnessed by a notary public or plan representative can be made remotely through live audio-visual technology, such as Zoom or another teleconferencing conference call, as long as certain requirements are met.

Broad application
This decision in Kinder Morgan Incorporated v. Joanne Crout is technically binding only on disputes arising in the Fifth Circuit (Louisiana, Mississippi and Texas.) However, the court’s ruling — that in the absence of a beneficiary designation, a married ERISA plan participant’s benefits must be paid to the surviving spouse — is non-controversial enough that it would practically apply to any case arising anywhere in the country.

The biggest takeaway for advisors, however, bears repeating: This case and other legal actions could have been avoided altogether by the simple act of your client updating their plan beneficiary form.