Distribution to Minor Beneficiary and Fiduciary Obligation to Minor

[Guest EE Bene]

A minor was named as the beneficiary of a cash balance DB plan. The amount payable to the minor is over $10,000 and the plan document does not say anything about how a distribution to a minor should proceed.

The minor has a custodial parent, but the law in this jurisdiction (CA) does not permit money to be transferred to a parent on behalf of a minor for sums over $10,000.

Is it possible to amend the plan to allow a transfer to a parent even though state law does not allow such transfers?

If the custodial parent or some other individual obtained a guardianship of the estate for the minor, we would be able to make a distribution, but no one has taken this step for the minor.

How long can the plan hold onto the money that is owed to the minor beneficiary before pursuing other distribution options?

How do a plan's fiduciaries duties to beneficiaries affect how it approaches distributions to minors? Even if we are able to amend the plan to allow distributions to a parent on behalf of a minor, does our fiduciary duty to the minor require us to take additional steps to ensure the minor actually receives the benefit of the money to be distributed?

The plan's main concern is to find an administratively feasible solution for these types of distributions. Thank you for any guidance or practical experience you have which might shed light on how to approach this situation.

[Guest EE Bene]

Here is an update on the progress I have made on these issues. If anyone has some input, it would be greatly appreciated.

One option on the table is to hire a professional fiduciary. That way the DB plan could make the distribution but allow some other party to handle the rest of the details (whether that is having a guardian or custodian appointed, or simply holding the funds untilt he minor reaches the age of 18). The main barrier here is the time and cost of setting something like this up.

Given that the plan administrator will be held to the standard of "prudent expert," I think the plan administrator needs to be careful how it makes distributions to minors. Since minors lack legal capacity, I think the plan administrator generally needs to look to state law on how these types of transfers are made (which means the money must be distributed to a custodian or guardian, rather than directly to the minor). Since a prudent expert would not give the money directly to the minor given the minor's lack of legal capacity, I think it needs to go elsewhere. Appointing a custodian is relatively easy, but state law is a little unclear on when this can be done (in terms of monetary cutoffs). I am also concerned that there is not as much protection when dealing with a custodian since there is no oversight. This is contrasted with having a guardian appointed, which has court oversight and requires court approval of the guardian.

The problem is that this is administratively burdensome for the plan administrator. So one other option on the table is to amend the plan to permit distributions to a parent of the minor (possibly by requiring the parent tp set up a custodial account for a bit of additional security). This raises a possible preemption issue. If the plan document permits such a distribution, is the plan then free from the confines of state law governing distributions to minors since ERISA preempts state law and the plan document governs? Then there is the question of whether we are acting as a prudent expert would. The last thing we want is for a parent to spend all the money and the minor to sue us (potentially long after the money is distributed since the statute of limitations for a minor typically does not begin to run until the minor turns 18). Using a custodial account raises the same issues as noted in the previous paragraph. There is more protection for the minor when using a custodial account as compared to a direct distribution to a parent, but is it enough to satisfy the "prudent expert" standard?

Finally, the administrator is also weighing the risk involved here. To date, the plan has never been sued by a beneficiary who was a minor at the time a distribution was made. This weighs in favor of choosing something simple (such as distributing to a parent on behalf of the minor).

[mbozek]

Before you spend plan money on hiring a fiduciary consider the following:

1. Most IRAs permit accounts to be opened by an adult over 18 or a parent or guardian of a minor who is the beneficiary. Many financial institutions that sponsor IRAs are established under federal charters which limit application of state laws. For example, IRAs sponsored by national brokerage firms usually state that they are governed under NY or DE law. The first question is whether a parent or guardian can open an IRA with a federally charted financial institution in CA for a minor child as IRA beneficiary.

2. If the IRA can be opened by a parent acting a guardian for a minor beneficiary, the plan can pay the beneficiary designated under the plan. If the plan permits a parent of a minor child to be the designated payee for the child as beneficiary then the plan can pay the benefits to the parent regardless of state law b/c the plan is only required to conform to ERISA, not state law. A recent case illustrates this concept. In Estate of Kensinger v. URL Pharma Inc, 3rd circuit, 3/20/2011, the spouse of a plan participant waived all rights to his 401k benefits in a property settlement incorporated in the divorce decree. However the participant never removed the spouse as the designated beneficiary under the plan. After the employee died the estate and the ex spouse both claimed the benefits. Following the 2009 Supreme Court decision in Kennedy v. Dupont Savings and Investment Plan, the district court awarded the benefits to the ex spouse as the beneficiary designated under the plan. The district court also held that the estate could not assert a claim against the ex spouse in state court to enforce the waiver in the divorce decree because the ex spouse was the beneficiary designated under the plan. On appeal the 3rd circuit upheld the payment of the benefits to the ex spouse as the designated beneficiary but reversed the part of the decision which prohibited the estate from pursuing a claim against the spouse in state court. The 3rd circuit reasoned that what transpires between the parties after the benefits are paid by the plan is solely a matter of state law for which the estate could pursue recovery of the funds as a breach of contract. Similarly a payment of the IRA benefits to a parent acting as the guardian of a minor child under an IRA account would be permitted under ERISA subject to a state agency asserting its rights against the parent after the funds are distributed.

3. Any state law prohibiting payment by the plan to a parent would be preempted by ERISA under the US Supreme Ct decision in Egelhoff v. Egelhoff.

4. The plan can only make such a distribution to the parent if there is specific langauge in the plan permitting payment to the parent for the benefit of a minor beneficiary. Needless to say the plan administrator needs to consult with counsel before making payment.

[Guest EE Bene]

I understand that the plan document may permit a distribution to a parent on behalf of a minor, BUT what happens if the minor later claims that the plan administrator did not fulfill its fiduciary duties by making such a distribution?

ERISA simply does not touch on the issue of whether a minor has capacity to receive money. Nearly every (if not every) state recognizes that minors do not have legal capacity to receive money. Therefore, state laws provide special safeguards that can be followed to functionally permit the minor to receive money or property. Just because the plan document says a certain action is allowed does not necessarily mean that action complies with ERISA. In fact, where the plan document is contrary to ERISA, a fiduciary cannot simply abide by the terms of the plan.

State laws make it pretty clear that distributing money to a parent on behalf of a minor is not prudent. So this is less of a question about ERISA preemption and more of a question on the proper standards of prudence under ERISA that might find guidance in state law.

I don't doubt that the minor would have a cause of action against the parent under state law if the parent misuses the money. But wouldn't the minor also have a cause of action under ERISA against the plan for breaching its fiduciary duty to the minor? What argument could the plan fall back on to justify the distribution to the minor's parent? Being a parent indicates nothing about that person's ability to manage the assets of another person. The minor will argue that including the option to distribute to his/her parent was a disretionary decision that did not satisfy the prudence requirement, as clearly indicated by the wealth of state laws which indicate being a parent is simply not enough assurance to ensure the minor's assets are protected. A plan administrator surely could not follow the plan document if it said that an adult's benefit could be paid to his/her parent on his/her behalf.

How would your answer change if you knew the parent had a gambling or drug problem? Do you still make that distribution? If not, what do you do? Do you then hire a professional fiduciary?

Kennedy v. Dupont doesn't deal with legal capacity. In fact, it is quite the opposite. Two consenting adults agreed to something outside the terms of the plan. ERISA specifically deals with how to designate a beneficiary and where the plan administrator must look to determine the proper beneficiary (the beneficiary designation made by the plan participant or the spousal survivor sections). The parent who would receive money on behalf of the minor IS NOT designated on the beneficiary designation form by the participant. Only the minor child is.

So what now?