Many people are surprised and shocked when they learn what happens when retirement account owners neglect simple details about the tax code and their accounts.
A review of some recent court cases brings the points home.
The newest case involved the 401(k) of the late Jeffrey Rolison, who had worked at Procter & Gamble for more than 30 years and accumulated a 401(k) balance exceeding $754,000.
When he enrolled in the 401(k) in 1987, Rolison named as sole beneficiary his live-in girlfriend. They broke up two years later.
From 2002-2014, Rolison had a non-marital relationship with a female co-worker and named her beneficiary of his life insurance and health benefits but never named her beneficiary of the 401(k).
Rolison died in 2015. The girlfriend from 1987 still was listed as sole beneficiary and was alive, so the 401(k) administrator paid the account balance to her.
Rolison’s brothers sued as co-executors of his estate, claiming the benefits should be paid to the estate.
The second girlfriend also sued, saying her status as beneficiary of the life insurance and health benefits indicated it was Rolison’s intention that she inherit the 401(k). The suit of the second girlfriend was dismissed, because she never was a beneficiary of the 401(k) and had no legal status that might give an expectation of rights in the account.
The brothers claimed Procter & Gamble violated its fiduciary duties or was negligent by not making clear to Rolison that the former girlfriend remained beneficiary of his 401(k).
But the company showed it sent Rolison numerous notices over the years advising him to check who was listed as beneficiary and change it if appropriate. The notices included instructions for accessing the account online.
The court ruled the employer wasn’t obligated to remind an employee specifically who was listed as beneficiary. The company also was able to show that Rolison logged into his 401(k) account multiple times and so had opportunities to review and change his beneficiary designation.
The estate lost the case, and the 401(k) balance went to the former girlfriend. The estate also probably spent a significant amount of money on litigation. (Procter & Gamble U.S. Business Services v. Estate of Jeffrey Rolison, Case #3:17-cv-00762, M.D. Pa.)
A case with similar issues was between a deceased 401(k) owner’s second spouse and the children from his first marriage.
The 401(k) owner designated his children as joint beneficiaries of the account.
The employer later was acquired by another firm and the 401(k) assets were rolled over into accounts at the new employer’s 401(k) plan.
The owner apparently failed to file a new beneficiary designation with the new employer. Under the rules of the new 401(k) plan, if a plan member failed to name a beneficiary the surviving spouse, if any, would be the sole beneficiary of the account.
After the employee died, the plan administrator notified the widow that she was the sole beneficiary.
The children filed a claim with the administrator. The administrator denied the children’s claim and asked a court to decide who was the beneficiary.
The deceased owner’s previous actions and the terms of his will indicated that he intended for his children to inherit all or most of his assets. But the court said that in a qualified retirement plan, only the latest beneficiary designation in the administrator’s records matters.
The children also argued that the beneficiary designation from the previous employer should have been applied. But the deal between the employers didn’t involve a merger of the two plans. The new employer’s plan was a separate plan and a new and separate beneficiary designation was required.
The court ruled that the widow was the sole beneficiary. (Kinder Morgan v. Crout, 5th Cir., No. 19-20037)
People often are surprised by the powers of a 401(k) administrator or IRA trustee, especially to terminate an account, distribute the assets, and trigger taxes on the owner.
In one case an IRA owner moved, and the custodian didn’t receive notification of the new address.
The custodian sent a letter to the owner at the last address saying the custodian was resigning from the account because of inactivity in the IRA and lack of contact with the owner.
When the owner didn’t reply with instructions on what to do with the account, the custodian distributed the balance by notifying the issuers of securities in the account to change the owner’s name from the custodian to the account owner.
The custodian issued a 1099-R reporting the distribution. The paperwork was sent to the owner’s address on record. None of the correspondence was forwarded to the IRA owner.
The IRS had the current address and sent the taxpayer an assessment of additional taxes for failing to include the IRA distribution in gross income.
After consulting with his CPA and doing a lot of paperwork, the IRA owner rolled the distributed assets to another IRA. The CPA then asked the IRS in writing to waive the 60-day limit for a tax-free rollover and accept the rollover as a tax-free transaction.
The IRS ruled in the IRA owner’s favor, so no additional taxes or penalties were due. But to avoid the taxes, the taxpayer had to undertake a lot of work, pay his CPA’s fees, and incur a $10,000 fee that the IRS charges on ruling requests.
A similar series of events involving the late actor James Caan had less favorable results, which I reviewed previously.
An important lesson is that an IRA custodian can decide to stop being custodian or resign as custodian of a particular account. When it does so, under conditions discussed in the IRA documents that few people read, a custodian can close an IRA and distribute the assets without any action by the IRA owner.
A common provision says the IRA custodian can resign and close the account 30 days after notifying the IRA owner of the intention, giving the IRA owner time to roll it over to a new custodian.
If the custodian doesn’t receive instructions from the IRA owner within 30 days, the account is closed and the account balance is distributed. Usually, a check is mailed to the IRA owner’s last known address or legal title to shares of stock or mutual funds are transferred to the IRA owner’s name.
The custodian also will send a Form 1099-R to both the IRS and the owner, listing the account balance as a distribution.
The IRA owner will have to include that amount in gross income for the year, unless he or she is able to roll it over to a qualified retirement account within 60 days of the distribution.
Sometimes the assets are transferred to a state’s unclaimed property fund. Then, the owner has to go through the state’s process to have the assets returned.
It’s important to be sure your IRA custodian and 401(k) administrator have your current address. Read all communications from them. Note any instructions and deadlines in the communications and be sure to make a timely response.
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