Nonqualified Plan Beneficiary Not Determined by Qualified Plan

A decision from The 9th U.S. Circuit Court of Appeals confirms a lower court ruling that a retirement plan membership letter and beneficiary designation form for a nonqualified plan “did not clearly and unequivocally incorporate by reference the entirety” of the terms of a plan sponsor’s qualified retirement plan.

For this reason, the terms of the qualified plan cannot determine a beneficiary under the nonqualified plan, the court ruled.

In the case E & J Gallo Winery v. Rogers, E & J Gallo Winery filed an interpleader action to determine the designated beneficiary under its Key Executive Profit Sharing Retirement Plan, referred to throughout the suit as the ERP. The benefit at stake in the case belonged to one Robert Rogers, a now-deceased former Gallo employee.

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Prior to the appellate court action, the district court denied Michele McKenzie-Rogers’ motion for summary judgment granting her the benefit, concluding that Mark Rogers was instead the proper beneficiary under the terms of the ERP. Michele McKenzie-Rogers, who was married to Robert Rogers at the time of his death, appealed the decision, leading to the current affirmation from the 9th Circuit.

The case turned on a dispute as to whether the terms of the Gallo Profit Sharing Retirement Plan, an Employee Retirement Income Security Act (ERISA) qualified plan, were incorporated into the ERP when certain of its terms were referenced in a 1988 membership letter to Rogers.

The appellate court noted that McKenzie-Rogers relies heavily on the letter’s third paragraph, which states that vesting, methods of payment and “all other matters” under the ERP will be determined under the Gallo Qualified Plan. Both the appellate and district court determined Michele McKenzie-Rogers reads “all other matters” too broadly, as the fourth paragraph of the 1988 letter specifically addresses the issue of designating a beneficiary, and informed Robert that if he did not do so in the accompanying form, payments would be automatically made to his estate upon his death.

The terms relating to beneficiary designation in the 1988 letter are in direct contradiction to the analogous provisions in the Gallo Qualified Plan. As explained in the appellate court decision, the Gallo Qualified Plan provides that benefits would be paid a) to the surviving spouse, or b) to the designated beneficiary, but only if there was no surviving spouse or if the surviving spouse had consented to the designated beneficiary, and would pass to the estate only if there were no surviving spouse or the surviving spouse had consented to the designated beneficiary.

Robert Rogers used the form to unambiguously designate his former wife, Audrey Rogers, as his primary beneficiary under the ERP, and his brother, Mark, as his secondary beneficiary. But, Audrey Rogers waived her rights as the primary beneficiary of the ERP in a “Waiver and General Release” that she signed on February 6, 2008.

“Nothing in the ERP governing documents provided that Robert’s marriage to Michele would void his prior beneficiary designation,” the court decision reads. The court also pointed out that the ERP is a nonqualified, top hat plan, exempted under ERISA from spousal consent requirements.

The text of the 9th Circuit decision is here.

 

Plan Design Is One Way to Stanch Outflows

Retirement readiness is the loser when participants take distributions before retirement, says BMO Retirement Services in a white paper.

In its nine-part educational series for plan sponsors, BMO shines a light on retirement plan issues including plan design and operational efficiency. The series is designed to assist plan sponsors cost-effectively help participants gain the most from their 401(k) plans.

The third paper in the last section, just released, deals with participant utilization, addresses plan leakage and ways plan sponsors can stanch outflows. Other topics in the section were participation, contributions and investing behavior.

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Auto features—enrollment, escalation and easily implemented investment options—can help guide participants along their way to a successful retirement, the paper notes. But addressing plan leakage from loans, in-plan distributions and cash-outs also plays a part.

Plan participants contribute about $175 billion to their retirement accounts each year, which is matched by an additional $118 billion in employer contributions, according to a HelloWallet study. Unfortunately, BMO notes in its paper, participants take an estimated $70 billion in non-retirement withdrawals each year—an offset of nearly 26% against current contributions.

Even though loans taken from a 401(k) plan are generally repaid by the participant, BMO believes they should still be viewed as plan outflows. Loans are issued to participants in pre-tax dollars but are repaid with after-tax dollars, the paper points out. And after the participant retires, those dollars are taxed again when distributed from the plan.

As a result, the Employee Benefits Research Institute (EBRI) projects an erosion of retirement income of 10% to 13% for those participants who stop contributing during the loan deferral period. Despite this threat to retirement readiness, nearly 20% of participants have an outstanding balance at any point, and about 40% of participants initiate at least one loan over any five-year period, according to research cited by BMO.

“While the causes of the outflows from 401(k) plans are important, the actions plan sponsors can take to prevent them are critical,” says Todd Perala, director of strategic initiatives in retirement and trust services of BMO Global Asset Management and the paper’s author. “The steps we recommend to clients include restricting participants to single loans for serious hardships only. After hardship withdrawals, sponsors should consider automatically restarting participant contributions.”

Perala also recommends that plan sponsors be frank in their communications about the negative impacts of plan loans, hardship withdrawals and cash-outs. “If possible, sponsors should amend their plans to allow for partial distributions by participants at retirement and permit new employees to roll over existing loans from prior providers,” he says.

BMO clearly outlines the three main types of plan leakage or outflows:

  • Loans: The leading cause of loan-related outflows are employees separating from plans; and more than two-thirds of participants with outstanding loan balances opt to take cash distributions rather than repay the loan. Even if repaid, these researchers believe 401(k) loans should be considered outflows as they are issued pre-tax, but repaid in post-tax dollars.
  • In-plan distributions: While plans allow hardship withdrawals, such outflows are often accompanied by a suspension of contributions for six months. This suspension, coupled with the opportunity cost of the initial hardship withdrawal, can result in participants losing a large portion of their retirement security.
  • Cash-outs: These are perhaps the most common outflow source and typically occur when participants leave their employer. Rather than rolling their retirement savings into an IRA or their new employer’s defined contribution plan, they opt for a cash distribution. This option typically subjects participants to taxation and a possible 10% IRS penalty.

 

BMO offers simple steps to limit leakage that could benefit participant outcomes:

  • Restrict loans: Allow one loan at a time, for serious financial hardships only.
  • Negotiate with the service provider: Allow participants to make loan repayments after they separate from service.
  • Automatically restart participant contributions six months after issuing a hardship distribution.
  • Develop targeted communications: Address the negative impacts of in-plan loans, taking hardship distributions and cashing out of the plan.
  • Amend the plan: Allow partial distributions by plan participants and permit new employees to roll over existing loans from prior providers.

 

“BMO Defined Contribution IQ: Outflows” can be downloaded from BMO’s website, where links and information about the other papers in the series are available.

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