A surprising number of families learn the painful lesson that divorce doesn’t fully resolve beneficial ownership issues with certain retirement accounts. Any plans governed under the Employee Retirement Income Security Act of 1974 (ERISA) must follow specific rules and provisions, which will override the provisions in a marital settlement agreement. The only exception to this rule is if the couple has a Qualified Domestic Relations Order (QDRO) as part of the divorce settlement. The effect of all this is that if you designate your spouse as a beneficiary under an ERISA plan, and neglect to change that beneficiary designation after divorce, the now ex-spouse will receive the asset at your death.
Many states, California included, have enacted laws that prevent an ex-spouse from inheriting from the estate of a prior spouse. California Probate Code § 5600 states that if an individual designates a spouse as a beneficiary on an account, that spouse will not inherit the asset if the spouse is divorced at the time the individual dies. This makes sense. In general, most people wouldn’t want to leave any assets to an ex-spouse at their death. This code section was enacted to cure the simple mistake of not updating beneficiary designations after divorce.
Unfortunately, accounts governed by ERISA don’t follow state laws and thus the protection provided in the Probate Code doesn’t apply. The US Supreme Court has consistently ruled that beneficiaries listed on ERISA plans will receive the asset even if the beneficiary is an ex-spouse. This is true even if the couple has been divorced for decades. The only exception is a QDRO. Many do-it-yourself divorces don’t include a QDRO because the parties may not know what it is or may not know that it is required for their assets. According to the IRS, a QDRO must contain specific information regarding the retirement plan including the nomination of an alternate beneficiary, with his or her last known mailing address, and the amount or percentage to be paid to the alternate beneficiary. A simple marital settlement agreement will not be deemed a QDRO absent the required language.
The best way to protect your ERISA accounts after divorce is to change the beneficiary designation. This will avoid the messy and ugly result of having an unwanted person inherit from your estate.