In our last newsletter, we discussed the importance of following up your estate planning. Beneficiary designations are an important part of that process, we emphasized. Your IRA beneficiary designation can be particularly challenging to get right. You may have already noticed, too, that things change.
A recent federal appellate decision (involving an Arizona state law) illustrates how things can go wrong. It involves an Individual Retirement Account — an IRA — set up by a man we’re going to call Gary Knight back in 1992.
When the account was set up Gary named his wife Cynthia as beneficiary. In 2008, when Gary and Cynthia divorced, they both lived in Arizona. Gary never changed his beneficiary designation. He also never made it clear that his failure to make a change might be intentional.
Gary died in 2012, four years after the divorce. Cynthia claimed that, since she was still listed as beneficiary, she ought to be entitled to the IRA proceeds. Gary’s son, as personal representative of his father’s estate, disagreed.
The revocation-on-divorce statute
What does happen to your estate plan when you divorce? The answer will vary depending on where you live (and die), and on what you mean by “estate plan”.
Arizona had long had a statute invalidating a will provision leaving property to a spouse upon divorce. In 1995 — after Gary set up his IRA — the Arizona legislature substantially expanded that statute.
Arizona Revised Statutes section 14-2804, as it now stands, includes a broad “revocation-on-divorce” provision. It covers all sorts of assets, and includes, among many other things, your IRA beneficiary designation. Under the current Arizona law, a divorced spouse is treated as having predeceased the IRA account owner unless the failure to update beneficiaries was intentional.
Not every state has the same broad provision. California, for instance, merely creates a presumption of revocation, rather than a complete revocation of the IRA beneficiary designation on divorce. And Gary’s IRA was managed by Charles Schwab, whose participation agreement indicated that federal law, and then California law, would govern its accounts.
You might already know that retirement accounts are often treated differently from other kinds of assets. That’s partly because many retirement accounts are controlled by the federal Employee Retirement Income Security Act of 1974 (ERISA), which expressly preempts state law on things like beneficiary designations.
Did Gary’s failure to change his beneficiary mean that the ERISA rules would apply? Was it a problem that the Arizona law was expanded to include IRAs after Gary’s account was established? Did it matter that the IRA agreement itself seemed to indicate that California law should apply?
The District Court ruling
Cynthia filed her lawsuit in federal court in California. She argued that California law should apply, and that in any case Arizona could not change the rules after the account was already established. She agreed that Gary’s IRA wasn’t actually controlled by ERISA. Still, she argued, the hard-and-fast rule about beneficiaries should be treated in the same fashion as ERISA. That would mean that Gary had to affirmatively change his beneficiary after the divorce.
The California court sent the entire case to its Arizona federal court equivalent. In Arizona, the federal judge ruled in favor of Gary’s estate. It found that Arizona law applied, and that Cynthia had no standing to object to the state law change. That meant Arizona’s revocation-on-divorce statute invalidated the beneficiary designation in her favor, and Gary’s IRA would go to his estate.
The Court of Appeals upholds the IRA beneficiary revocation
Last month the federal Ninth Circuit Court of Appeals upheld the District Court decision. According to the appellate judges, Arizona’s revocation-on-divorce statute applies, and it works to invalidate Cynthia’s designation as beneficiary on Gary’s IRA.
The Court of Appeals did disagree with the District Court in one particular, though it did not change the outcome. According to the appellate court, Cynthia did have standing to raise her argument about Arizona’s statute invalidating an existing contractual arrangement. Nonetheless, her argument was not persuasive. Because her interest was as a beneficiary, and not an account owner, she had no vested interest at the time of the statutory change. Lazar v. Kroncke July 14, 2017.
What it means for you
We’ll say it again: beneficiary designations are an important part of your estate planning. Perhaps Gary consciously intended to leave a substantial asset to his ex-wife four years after their divorce. If so, he needed to address the issue intentionally, rather than rely on default rules. If he intended to remove her as beneficiary, he should have filled out the proper form, signed it, and sent it to Charles Schwab.
We get it. Life is complicated, and sometimes things don’t get done. We’re overdue for our semi-annual teeth cleaning, too — and don’t even get us started on how hard it is to get going on yard work. But beneficiary designations are easier than both of those things; Gary could have downloaded the Charles Schwab beneficiary designation form (we just found it online with a simple search in less than ten seconds) and filled it out in about ten minutes.
When you complete your estate plan with us, we will talk to you about beneficiary designations. We can complete the forms, and review your current designations. We can’t get them ourselves, though — you have to tell us about the assets, and request the current beneficiary information. It’s not that hard to update your IRA beneficiary designations, though — or any of the other beneficiary information you have listed on various accounts and assets. Maybe you (and we) could start with a list.