Negligence of Basic Details: Four Instances of Heartbreak Stemming from IRA Neglect
Many individuals are often taken aback and left dumbfounded when they come to terms with the consequences of disregarding fundamental details related to tax laws and their retirement accounts.
A review of recent court cases sheds light on this matter.
The most recent case revolved around the 401(k) of the late Jeffrey Rolison, who spent over three decades at Procter & Gamble and amassed a 401(k) balance surpassing $754,000.
At the time of enrolling in the 401(k) in 1987, Rolison named his live-in girlfriend as the sole beneficiary. They parted ways two years later. From 2002 to 2014, Rolison was in a non-marital relationship with a female colleague and designated her as the beneficiary of his life insurance and health benefits. However, he never named her as the beneficiary of his 401(k).
Rolison passed away in 2015. The girlfriend from 1987 was still listed as the sole beneficiary, and she was alive, so the 401(k) administrator paid the account balance to her.
Rolison's brothers, acting as co-executors of his estate, sued, claiming the benefits should be paid to the estate. The second girlfriend also filed a lawsuit, stating that her status as the beneficiary of the life insurance and health benefits indicated Rolison's intention for her to inherit the 401(k). However, her lawsuit was dismissed because she had no legal standing to lay claim to the 401(k).
The brothers accused Procter & Gamble of breaching its fiduciary duties or being negligent by not informing Rolison that his former girlfriend remained the beneficiary of his 401(k). The company, however, produced numerous notices sent to Rolison over the years advising him to check his beneficiary and make any necessary changes. The notices even included instructions for accessing the account online.
The court ruled that the employer was not obligated to remind Rolison specifically who was listed as the beneficiary. The company was able to demonstrate that Rolison had logged into his 401(k) account multiple times, providing ample opportunities for him to review and modify his beneficiary designation. As a result, Rolison's former girlfriend retained the 401(k) balance, and the estate likely incurred significant legal expenses. (Procter & Gamble U.S. Business Services v. Estate of Jeffrey Rolison, Case #3:17-cv-00762, M.D. Pa.)
A case with similar circumstances involved the deceased 401(k) owner's second spouse and his children from his first marriage.
The 401(k) owner designated his children as joint beneficiaries of the account. However, he failed to update his beneficiary designation when the 401(k) assets were rolled over into an account at the new employer's 401(k) plan. Under the new plan's rules, if the plan member failed to name a beneficiary, the surviving spouse, if any, would be the sole beneficiary of the account.
After the owner's death, the plan administrator informed his widow that she was the sole beneficiary. The children disputed this and filed a claim with the administrator. However, the administrator denied their claim and took the matter to court.
The owner's previous actions and will indicated that he intended for his children to inherit most of his assets. However, the court ruled that in the case of a qualified retirement plan, only the most recent beneficiary designation in the administrator's records mattered. The children also argued that the beneficiary designation from the previous employer should be applied, but since there was no merger of the plans, a new beneficiary designation was required.
The court ultimately ruled in favor of the widow, making her the sole beneficiary. (Kinder Morgan v. Crout, 5 Cir., No. 19-20037)
People often find themselves shocked by the power held by 401(k) administrators and IRA trustees, especially in terms of terminating an account, distributing assets, and triggering taxes on the owner.
In one case, an IRA owner failed to inform their custodian of a change in address. The custodian then ceased being the custodian of the account due to inactivity and lack of contact with the owner. When the owner did not provide instructions regarding the account, the custodian distributed its contents.
The custodian issued a 1099R reporting the distribution, and the IRS assessed additional taxes on the owner for failing to include the distribution in their gross income. With the help of their CPA and a significant amount of paperwork, the owner managed to roll over the distributed assets to another IRA, but they incurred substantial expenses, including fees for their CPA and a $10,000 fee for the IRS ruling request. (Review of Previously Covered Case Involving Late Actor James Caan)
A critical takeaway is that an IRA custodian may choose to relinquish custody or resign as custodian of a specific account under specific conditions, as outlined in the IRA documentation. In such circumstances, the custodian may close the IRA and distribute the assets without the owner's involvement.
In a typical scenario, the IRA manager has the right to resign and close the account 30 days after informing the IRA owner of their intention, granting the owner time to move the account to a new custodian.
If the IRA owner fails to provide instructions within this 30-day period, the account is shut down, and the account balance is disbursed. This often involves mailing a check to the owner's latest address or transferring shares of stock or mutual funds to the owner's name as the legal title holder.
Simultaneously, the custodian will issue a Form 1099-R to both the IRS and the owner, detailing the account balance as a distribution.
The owner must then report this amount as their yearly gross income, unless they can transfer it to a qualified retirement account within 60 days of the distribution.
At times, the assets may be transferred to a state's unclaimed property fund. For the owner to reclaim these assets, they must navigate the state's reclamation process.
It's crucial to ensure your IRA custodian and 401(k) administrator have your current mailing address. Attentively read all communications from them, take note of any instructions and deadlines, and promptly respond accordingly.
- In the case of James Caan's IRA, failure to provide a change of address led to the custodian distributing the assets, triggering ira penalties for Caan when he failed to include the distribution in his gross income.
- If an IRA owner does not update their beneficiary designation following a rollover from a 401(k) plan, the most recent beneficiary designation in the administrator's records will determine the distribution of the assets, even if the previous intentions were different as indicated in the owner's will.
- Procter & Gamble was not obligated to remind Rolison specifically who was listed as the beneficiary of his 401(k), as they had provided numerous notices advising him to check his beneficiary and make any necessary changes, and Rolison had logged into his account multiple times, providing ample opportunities for him to review and modify his beneficiary designation.
- When the 401(k) beneficiary designation is not up-to-date, inheriting IRAs can lead to complex legal matters, with courts ruling that only the most recent beneficiary designation in the administrator's records matters.
- Inherited IRAs can come with their own set of challenges, such as the need for the 401(k) beneficiary to roll over the assets to a new IRA within 60 days or face potential taxes and penalties.
- In the absence of an IRA custodian, ira distributions may be handled by the state's unclaimed property fund, requiring the owner to navigate a reclamation process in order to regain control of the assets.
