Invalid Beneficiary Designation Form

[Guest Thornton]

On 2/27/06, a participant in ABC Corp's 401(k) plan executed a beneficiary designation form naming his four adult children from a previous marrage as his beneficiaries. On 2/28/06, Company A sent him a confirmation of the beneficiary designation showing his children as the beneficiaries. His current wife writes on the confirmation "I consent to the above" and signs and dates the form. The participant dies on 1/30/08. Clearly, this was not a valid waiver, and the plan administrator, citing the invalid spousal consent, has indicated the account balance belongs to the widow, not the children. However, the widow does not want the assets, wishing to honor her husband's designation. (I know, this is a rare event, but it happens sometimes!) Anyway, she doesn't need the money.

Question: Is there a way to validate the beneficiary designation? The widow is willing to sign an affidavit to the effect that she did consent and waived her rights to the plan assets. Any ideas will be appreciated. Thanks.

[jevd]

A Qualified Disclaimer under IRC 2518 may work depending on the plan language regarding beneficiary hierarchy.

[david rigby]

Others will know better than I.

IRC 2518 is part of Subtitle B of the Internal Revenue Code, and begins "For purposes of this subtitle..."

Does that mean it does not apply to anything under Subtitle A, including IRC 401(etc.)?

[jevd]

Others will know better than I.

IRC 2518 is part of Subtitle B of the Internal Revenue Code, and begins "For purposes of this subtitle..."

Does that mean it does not apply to anything under Subtitle A, including IRC 401(etc.)?

As far as my understanding goes, subtitle B applies to subtitle A.

In fact a recent Revenue Ruling allows a Qualified Disclaimer of retirement plan assets to stand even though the beneficiary disclaiming took distribution of the RMD for the year of death. That would imply that IRC Sec 2518 applies. I'm not an attorney or CPA. Maybe someone else can explain more fully.

[Peter Gulia]

Here’s an overview of a few of the wider points.

A disclaimer (also called a renunciation in some States) is a writing in which a beneficiary states that he or she doesn’t want to receive a benefit. To be valid and, if desired, to achieve tax purposes, the disclaimer must carefully state specified conditions.

Is a disclaimer permitted under a retirement plan? A retirement plan won’t permit a participant to disclaim his or her benefit because a retirement plan provides that a participant cannot forfeit or transfer any right he or she has under the contract. But a retirement plan might permit a beneficiary to disclaim a benefit. See IRS General Counsel Memo 39858 (Sept. 9, 1991); IRS Letter Rulings 9226058, 9037048, 8922036. If permitted (or at least not precluded) by the retirement plan, a plan administrator may accept a beneficiary’s disclaimer.

If a beneficiary makes a valid disclaimer that the plan administrator accepts, the retirement plan benefit will be distributed (or distributable) as if the beneficiary/disclaimant had died before the participant’s death or before the creation of the benefit disclaimed.

Tax consequences: If a beneficiary makes a valid disclaimer that also meets all requirements of IRC § 2518 (see below), the disclaimed benefit won’t belong to the disclaimant for Federal estate, gift, and generation-skipping-transfer tax purposes. IRC § 2518; 26 C.F.R. § 25.2518-1(b). Many States have a similar rule for State death tax purposes. See, for example, 72 Pa. Consol. Stat. § 9116©. The Internal Revenue Code’s qualified-disclaimer provision doesn’t refer to Federal income tax and doesn’t say that the disclaimed benefit isn’t income. But for tax years that began or begin after 1981, IRC § 402 taxes “any amount actually distributed” from a § 401(a) plan.

Requirements: To be effective for Federal tax purposes, a disclaimer must meet all of the following requirements:

• The disclaimer must be made before the beneficiary accepts or uses any benefit.

• The disclaimant must not have received any consideration for the disclaimer.

• The writing must state an irrevocable and unqualified refusal to accept the benefit.

• The benefit must pass without any direction by the disclaimant.

• The disclaimer must be in writing and must be signed by the disclaimant.

• The writing must be delivered to the plan administrator.

• The writing must be so delivered no later than nine months after

the date of the participant’s death, or

the date the beneficiary attains age 21, whichever is later.

• The disclaimer must meet all requirements of applicable State law.

IRC § 2518; 26 C.F.R. § 25.2518-2; GCM 39858, 1991 WL 776304 (Sept. 9, 1991); see generally, UNIFORM DISCLAIMER OF PROPERTY INTERESTS ACT.

State law may provide further requirements. For example, in some States a disclaimer must state the disclaimant’s belief that he or she has no creditor that could be disadvantaged by the disclaimer. Even without a requirement for such a statement, some State laws apply fraudulent-transfer doctrines to a disclaimer that, if given effect, would disadvantage a disclaimant’s creditor. In some situations, especially when the beneficiary is a minor or an incapacitated person, a disclaimer may require court approval. Even when court approval isn’t required, State law may require that a disclaimer isn’t valid unless it is filed in the appropriate probate court. In addition to State law and tax-law requirements, a retirement plan may impose further requirements.

Of course, this is discussion among practitioners, and not advice to anyone.

[Guest mjb]

Under reg. 25.2518-1©(1)(i) a disclaimer is valid under IRC 2518 even if it is not valid under state law.

Beneficiary may elect to receive a MRD required before year end and disclaim future payments if all other requirments of IRC 2518 are followed since 2518 permits partaial disclaimers.

Sucessive beneficaries may each disclaim all or part their interest in benefits under 2518.

Beneficary disclaimers must comply with MRD rules for designation of beneficary by Sept 30 of year following year of death.

[Peter Gulia]

While mjb is correct in what he or she wrote, some further background might be helpful to some readers.

There are two different analyses: (1) whether a retirement plan should accept a disclaimer and, if the plan accepts it, (2) what tax effect it might or might not have.

Nontax law (usually ERISA)

Even if a disclaimer could qualify for some or all Federal tax purposes, it might not accomplish much if the retirement plan doesn’t accept it. A plan administrator decides whether the plan permits or precludes a beneficiary’s disclaimer, and a plan might specify (or a plan administrator in its discretion might decide) what conditions a disclaimer must meet for the retirement plan to accept it. If a plan isn’t governed by ERISA, it’s likely that at least one State’s law will be relevant in the plan administrator’s evaluation on whether to accept the disclaimer. If a plan is ERISA-governed, a plan administrator might assume that ERISA’s preemption of “State laws insofar as they may … relate to” the plan allows the plan administrator to ignore State laws. Under that view, a disclaimer complies with applicable State law because the State law that might not be met isn’t applicable. Some documents of some ERISA-governed plans recognize a disclaimer only if it complies with a relevant State’s law. And if a plan is silent on what conditions make a disclaimer, the plan might permit or require its administrator to interpret what the word disclaimer means.

Federal tax

26 C.F.R. § 25.2518-1©(1)(i) states that “[a] disclaimer of an interest CREATED IN A TAXABLE TRANSFER BEFORE 1982 which [sic] otherwise meets the requirements of a qualified disclaimer under section 2518 and the corresponding regulations but which [sic], by itself, is not effective under applicable local law to divest ownership of the disclaimed property from the disclaimant and vest it in another, is nevertheless treated as a qualified disclaimer under section 2518 IF, under applicable local law, the disclaimed interest in property is transferred, as a result of attempting the disclaimer, to another person without any direction on the part of the disclaimant.” There is no similar rule stated for a disclaimer of an interest created after 1981.

A possible (but not my) interpretation 26 C.F.R. § 25.2518-2 is that a disclaimer need not be effective under nontax law if its effect meets all of the conditions required by the tax regulations. In practice, it’s rare to find a disclaimer that’s ineffective under nontax law but nevertheless qualifies for IRC § 2518 tax treatment. Often, an ineffective disclaimer can’t meet the tax condition that the benefit must pass without any direction by the disclaimant. (If a disclaimer isn’t effective and thus the beneficiary/disclaimant isn’t deemed to have predeceased, what makes it proper for the retirement plan not to provide the benefit to the named beneficiary?) Likewise, it’s not clear that a disclaimer is irrevocable if the disclaimer is, under nontax law, void or ineffective.

And even for Federal tax purposes, treatment as a qualified disclaimer under IRC § 2518 isn’t the whole ballgame. Although following IRC § 2518 provides some relief for some other Federal tax purposes, it doesn’t directly provide relief for Federal income tax purposes. If a disclaimer isn’t effective under nontax law (whether State law or ERISA) one might worry about what arguments the IRS could assert concerning why the beneficiary isn’t really rid of the income.

mjb is right to explain that a disclaimer of a specified portion of a benefit can be permitted. Receiving the first minimum-distribution payment but promptly disclaiming all else is one frequent use of the partial-disclaimer opportunity.

[Guest mjb]

For now I will limit my comments to that part of your post that discusses disclaimers under Federal tax law but I will respond to the rest of your post at later time. Frankly I dont know where you came up with your conclusions on the need for a disclaimer of property after 1981 to comply with state law.

The reason there is no similar language in the regulatons for valid disclaimers after 1981 not having to meet the requirements for a disclaimer under local law is because disclaimers of property after 1981 are exempt from compliance with state law renunciation requirements if the transfer complies with IRC 2518©(3) instead of 2518(b).

"For interest in property created after 1981 renunciations need not be valid under state law to be a qualified disclaimer if the renunciations meet the requirements of IRC 2518©(3). Estate of Dancy v. IRS, 872 F2 84, 85.

According to HR Rep No. 201, 97th Congress First Session, P 190-191, reprinted in IRS CB 1981-2, 352, 392:

"In order to provide uniform treatment among the States, the committee believes that where an individual timely transfers the property to the person who would have received the property had the transferor made an effective disclaimer under local law, the transfer will be treated as a disclaimer ... provided the transferor has not accepted the interest or any of its benefits. Under 2518©(3) local law will be applicable to determine the identity of the transferee but the transfer need not satisfy any of the requirements of the local disclaimer statute."

Under IRC 2518©(3) a disclaimer which is valid under IRC 2518(a) only needs to meet three requirements:

1. the property is transferred with 9 months after the death of the owner

2. the transferee did not accept the interest or any of its benefits

3. the transfer is to a person who would have recieved the property had the transferor made a qualfied disclaimer under state law.

There is no requirement that a valid disclaimer under 2518©(3) be irrevocable as required under 2518(b) or meet any other requirement for a disclaimer under IRC 2518(b) that is not required under IRC 2518©(3).

[Peter Gulia]

mjb, thank you for the very helpful information.