Q: I have been searching for an answer to a unique question. X died leaving a sizeable 401(k). He and his former spouse had signed an earlier separation agreement forfeiting any right in the other's 401(k) accounts. However, X didn't change the beneficiary designation with his 401(k) trustee.
The spouse of X is willing to give up the money in X's 401(k) but the company says that they have to pay it to the spouse. Would a renunciation work in this case? --KB via email
A: X's wife can probably disclaim (or renounce) this inheritance if he died less than nine months ago -- although her ability to do so may depend on the rules of the 401(k) plan**; but a disclaimer won't solve the problem unless X remembered to name his chosen heir as a contingent beneficiary on the 401(k) account, or at least to name that person in his will.
The real problem here is that X didn't file the necessary paperwork with his 401(k) plan administrator. This seemingly innocuous omission can lead to disaster for your survivors. (See my earlier post 'An Estate Planning Nightmare: Death, Taxes, and a Missing 401(k) Waiver').
A named beneficiary (or an heir named in a will) always has the option to disclaim an inheritance within 9 months of the decedent's death.
When the primary beneficiary disclaims the money, the 401(k) account automatically goes to the contingent beneficiary.
If there is no contingent beneficiary on the account, the money would be paid into X's estate. Your estate is always the default beneficiary on a retirement account if you neglected to name one.
If the 401(k) account is paid to X's estate, it will go to the heirs he named in his will.
And what if X left no will? In that case, his estate will be distributed according to his state's intestacy law. In most states, that means it will be divided between his surviving spouse and children. In other words, his separated-but-not-divorced wife is probably one of the intestate heirs.
I'm not sure whether an intestate heir can disclaim an inheritance. If she can, that might work out okay if X wanted the money to go to his children. But a disclaimer won't have the desired result if X wanted to leave the account to his second cousin, or to his new sweetheart. Intestacy laws have a strict pecking order; and they make no provision for your nearest and dearest who aren't also your blood relatives.
Even in the best case scenario, X's family will have to pay a lawyer to sort all this out. And if the heirs end up getting the 401(k) money through X's estate, it will be on less favorable tax terms than if they'd inherited as named beneficiaries on the account.
The bottom line: This is another telling example of why you should keep your 401(k) account beneficiary designations up to date!
** My original post didn't include this caveat. A 401(k) plan's rules can never be more liberal that what is permitted by law, but they can be, and sometimes are, more restrictive.
Please send your questions to Lynn@LynnBrennersFamilyFinance.com. I'm sorry I can't respond personally to every email. Questions are only addressed online.