The $300,000 beneficiary form blunder

Stepchildren might not have the same legal standing as biological children if beneficiary forms don't make that clear.

In a recent case, the 5th U.S. Circuit Court of Appeals ruled that a plan administrator didn't abuse her discretion in concluding that stepsons weren't “children” under the terms of their stepfather's employer retirement plan. As a result, when John Hunter, a plan participant, died with no beneficiary, his stepchildren were disinherited and other family members got the money — $300,000 under the plan's default-beneficiary rules (Herring v. Campbell, No. 11-40953, Aug. 7)

He retired from Marathon Oil Co. and participated in the company's qualified retirement plan. The plan allowed Mr. Hunter to name a primary and secondary beneficiary.

He named his wife, Joyce Hunter, as primary beneficiary but didn't name a contingent beneficiary. After she died in 2004, he didn't update his plan beneficiary form.

Mr. Hunter died in 2005.

Because he died without a living primary or contingent beneficiary, his plan defaulted to one of five beneficiaries in the following order: his surviving spouse, surviving children, surviving parents, brothers and sisters, and his estate.

Because Mr. Hunter's wife was already deceased, the plan's next default beneficiary was his surviving children. He didn't have any biological or legally adopted children, but he did have two stepsons, Stephen and Michael Herring.

The employer plan administrator, Eileen Campbell, looked into whether his two stepsons should inherit the funds. However, she decided that his stepsons didn't qualify as children because they weren't his biological children and were never adopted by him.

Under the terms of the plan, because Mr. Hunter's wife had predeceased him, he had no biological or legally adopted children, and he had no surviving parents, the plan distributed the funds to the next category of default beneficiaries — his six brothers and sisters.

COURT CHALLENGE

The stepsons later challenged the distribution, arguing that they were Mr. Hunter's “children” and should have received the $300,000. They cited their close relationship with him, the fact that he left his estate to them and the fact that he referred to them as his “beloved sons” in his will.

They also claimed that they were entitled to the plan funds under the Texas probate law doctrine of “equitable adoption” (estoppel).This happens when a “parent” agrees with a “child” to adopt that child, and that child behaves in a loving and supportive way to the parent, even though no formal adoption was filed.

The first court, a district court, ruled in favor of the stepsons and concluded that the plan administrator “abused her discretion by failing to consider the stepsons' claims of adoption by estoppel.” The plan administrator then appealed the district court's ruling.

The appeals court reversed the lower court's ruling and agreed that stepchildren aren't children entitled to the retirement plan assets, and thus the retirement plan funds were properly distributed to Mr. Hunter's siblings as the default beneficiaries of the plan. The stepsons were disinherited.

If Mr. Hunter named them as contingent beneficiaries, the stepsons could have inherited the retirement plan assets.The failure to name a contingent beneficiary could have been fixed if the retirement plan beneficiary form simply had been updated.

When there is no beneficiary named on the plan beneficiary form, the retirement plan documents dictate who gets the money by default.

Never allow your client's retirement funds to go to the plan's default beneficiary; your client should dictate who gets the retirement assets, not the plan's default language.

Based on Mr. Hunter's will and other documents, it certainly appeared that he wanted his retirement funds to go to his stepsons, not his brothers and sisters.

Mr. Hunter's will left everything to his stepsons, but wills do not address who gets individual retirement account or employer plan funds, unless the estate is the beneficiary. Your client's intentions won't trump what's on the beneficiary form.

The time and fees associated with this litigation likely were significant.

The stepsons began challenging the plan administrator's decision in 2008 and the appeals court ruling was this August. Thus, this issue has been fought for four years, with legal expenses for two courts, and after all that, the stepsons still lost their case.

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