Parents lose out on 401(k) windfall

The 8th U.S. Circuit Court of Appeals recently ruled that a surviving spouse's promise to waive her rights to her husband's 401(k) funds by signing a postnuptial agreement was invalid because the agreement was written incorrectly.

As a result, she didn't waive her rights and inherited the money that was supposed to be paid to her husband's parents.

Michael Cox worked for MidAmerican Energy Co. and participated in the MEC 401(k). Between 1997 and 2004, he and Kathy Cox had been twice married and divorced.

In September 2004, while he was single, Mr. Cox named his parents as the beneficiaries of his 401(k). In 2010, Mr. and Ms. Cox married for the third time.

Before the third marriage however, the couple signed a prenuptial agreement.

To the couple's credit, or perhaps to that of their advisers, they knew that a prenup couldn't be used to waive spousal rights in a 401(k) plan, as only a spouse can waive those rights. So three weeks after they were remarried, they re-executed the same prenup March 26, 2010.

At this point, the prenup was now a postnup.

The agreement said that in the event that the marriage ended, they each waived their rights to each other's property. With respect to Mr. Cox's 401(k), the agreement specifically stated that his 401(k) would remain his and that Ms. Cox disclaimed all rights to it, and agreed not to seek a qualified-domestic-relations order in a future divorce with respect to the 401(k) plan.

RIGHTS UNDER ERISA

The postnup also addressed Ms. Cox's rights under the Employee Retirement Income Security Act as a surviving-spouse beneficiary of Michael's 401(k). It said that Ms. Cox irrevocably consented to any change in beneficiary or form of benefit payments, without requiring her further consent.

It also said that she agreed to consent, in writing, to waive her rights to his retirement assets at any time.

A little over a year after their third marriage, Mr. Cox filed for divorce May 4, 2011. The divorce documents referenced the postnup that he and Ms. Cox had signed, and requested that their property be divided according to it.

However, Mr. Cox died seven days later, before the divorce was finalized. At the time, his most recent marriage to Ms. Cox had been for more than one year.

After his death, Mr. Cox's parents and Ms. Cox argued over who should receive the 401(k) funds. The 401(k) plan administrator thought that the parents should get the money and sent Ms. Cox a letter to sign a waiver to any rights in the 401(k) plan.

Ms. Cox refused to sign that waiver. The plan administrator then filed an “interpleader” action in which it asked the court to decide who should get the money.

The District Court ruled that the postnuptial agreement wasn't effective to waive Ms. Cox's rights to the 401(k) funds. Despite the various provisions of the agreement, Ms. Cox never acknowledged the effect of signing a waiver, which is required under ERISA.

As a result, the court said that Ms. Cox didn't properly waive her rights to Mr. Cox's 401(k), and awarded the funds to her as his surviving spouse. His parents appealed the decision but lost there as well.

In analyzing the case, the Court of Appeals said that ERISA governs the distribution of Mr. Cox's 401(k) plan.

Under ERISA, surviving spouses are automatically entitled to retirement benefits. However, a married plan participant can name someone other than his or her spouse as the beneficiary, but only if many strict rules under ERISA are met.

The court said that the agreement didn't meet the ERISA rules, because it failed to inform Ms. Cox, in clear terms, that she had a right to receive the 401(k) funds and that she was waiving that right.

The agreement, which the court calls an “antenuptial agreement,” failed to include an acknowledgement of the effect of the waiver. Because the agreement wasn't written properly, the soon-to-be-but-not-yet-ex-wife got everything.

In hindsight, rather than executing a postnup, Mr. Cox and Ms. Cox probably should have executed the 401(k)'s own documents for her to waive her spousal rights.

Postnuptial agreements can waive spousal benefits, but only if the agreement meets ERISA requirements.

The lesson for financial advisers: Suggest that clients think long and hard before marrying the same person for a third time.

Ed Slott (irahelp.com), a certified public accountant, created the IRA Leadership Program and Ed Slott's Elite IRA Advisor Group.