To help employers properly administer their 401(k) plans, in 2022, Foley & Lardner LLP is authoring a series of monthly “401(k) Compliance Check” newsletters. This article includes some tips for administering 401(k) plan beneficiary designations.

In last month’s 401(k) Compliance Check, we discussed best practices for drafting a 401(k) plan summary plan description (SPD). This month we provide some best practices for plan administrators’ handling of 401(k) plan beneficiary designations.

Why is This Topic Important?

401(k) plan sponsors and administrators have a vested interest in making sure plan participants have properly completed and filed their beneficiary designations. The majority of beneficiary designation issues affecting plan sponsors and administrators arise after a participant has passed away and is no longer able to make changes. In order to prevent costly and time-consuming, competing claims and potential litigation related to 401(k) account balances, plan sponsors and administrators should strongly consider investing more time in developing and following through  with best practices related to beneficiary designations that are intended to avoid any future, competing claims and potential litigation. In addition to helping plan sponsors and administrators satisfy their fiduciary obligations in connection with 401(k) plan administration under the Employee Retirement Income Security Act of 1974 (ERISA), using best practices in connection with beneficiary designations should bring affected, 401(k) participants peace of mind that their 401(k) account balances will pass to their chosen beneficiaries in the event a participant dies before they have received a distribution of their entire 401(k) account balance. In summary, prudent plan administration as required by ERISA that results in proper completion and filing of beneficiary designations should yield the following results:

• 401(k) participants make the affirmative decisions as to the beneficiary and recipient of plan funds upon their death and not the 401(k) plan document by default (although there are beneficiary designation limitations discussed below for a married participant who wants to name a non-spouse beneficiary);

• Any possibility of unnecessary and expensive litigation and adverse tax consequences involving competing claimants to a participant’s 401(k) account balance should be avoided;

• Intended 401(k) beneficiaries will have much better opportunities to plan their own personal, financial and tax affairs based on knowing there should be no challenges to their rights to a deceased participant’s remaining 401(k) balance; and

• Plan sponsors and administrators should be considered as complying with their fiduciary obligations related to beneficiary designations and, therefore, hopefully avoid any adverse regulatory action in connection with this issue by the Internal Revenue Service or U.S. Department of Labor.

What Actions Should Plan Administrators Consider as Best Practices in Connection with 401(k) Beneficiary Designations?

Following the steps below should help the plan administrator ensure that 401(k) beneficiary designations are being handled in a prudent manner in accordance with ERISA fiduciary requirements and are as up-to-date as possible in order to satisfy 401(k) participant objectives and avoid unnecessary, competing claims, litigation and expense in connection with a participant’s death. 

1. • Consider use of a plan administrator checklist regarding what 401(k) plan administrators and also participants need to consider in connection with proper completion and filing of beneficiary designations.

   • Try to retain a complete and current address for each of the participant and named primary and contingent beneficiaries, which best practice also should be reflected in the 401(k) plan’s SPD and periodic participant notices sent by the plan administrator.

   • Send participants annual reminders to review and update, if needed, beneficiary information in connection with any pre-death life cycle event applicable to the participant (e.g., divorce, birth of a child, remarriage, etc.).

   • In addition to notification provided in the 401(k) plan’s SPD, plan administrators should periodically notify all participants that if they are married at time of death, there must be a written, spousal consent on file in order for a non-spouse beneficiary to be recognized as the proper beneficiary.

   • In connection with any spousal consent that is normally required to be made in the actual presence of a 401(k) plan representative or notary public, plan sponsors and administrators should stay informed about existing, temporary, COVID relief permitting use of an electronic system to meet these requirements, which relief currently is set to expire on December 31, 2022.

What Should 401(k) Plan SPDs Say about Beneficiary Designations?

The 401(k) Plan SPD should provide participants with further details about the importance and implications of making a valid beneficiary designation, including the following information to assist participants:

• Acceptance of a plan participant’s 401(k) beneficiary designation does not mean it has been approved by the plan administrator since the approval process normally occurs after a participant’s death.

• State the rights, benefits and responsibilities applicable to participants in connection with their designation of beneficiaries. Remind married participants that written, spousal consent is required to designate a non-spouse as the beneficiary, plus that either plan administrator acknowledgment or notarization is also required.

• Inform the participant that the 401(k) beneficiary designation overrides the participant’s will, unless the participant’s estate is designated as the beneficiary.

• Advise the participant whether the participant’s ex-spouse will automatically be removed as the primary 401(k) account beneficiary in the event of a divorce.

• Provide clear guidance to beneficiaries regarding how to make a claim in connection with a participant’s death.

• Remind beneficiaries that tax penalties may apply if 401(k) death benefits are not distributed from the plan in accordance with required minimum distribution (RMD) requirements under applicable law.

What Actions Should be Taken in Connection with Beneficiary Designation Document Retention?

• Plan sponsors and administrators should keep in mind that participant-level records such as beneficiary designations need to be retained for an indefinite period of time and not the normal six years relating to plan-level records.

• If possible, a dual verification system should be used by the plan administrator to maintain proper security surrounding beneficiary designations and future changes in order to avoid fraud.

What Specific Actions Should a Plan Administrator Take Annually?

• Plan administrators should coordinate with recordkeepers to check plan records at least annually to confirm 401(k) plan participants have properly completed their respective beneficiary designations.

• Plan administrators also should inform alternate payees in the event of divorce or beneficiaries entitled to account balances in the event of a participant’s death what needs to be completed with respect to their own beneficiary designations pending distribution of a 401(k) account balance. Alternate payees after a divorce and beneficiaries after a 401(k) participant’s death also need to be reminded of the importance of keeping the plan administrator informed of their current address and contact information.

In Summary

• 401(k) account balances may be one of the largest, if not the largest, death benefits related to an individual, so special care and attention needs to be taken by plan sponsors and administrators to make sure their 401(k) plan participants are constantly reminded of beneficiary designation requirements.

• The 401(k) participant should be the one deciding where 401(k) plan funds go upon the participant’s death as opposed to the default provisions of the applicable 401(k) plan document. Plan administrators need to provide clear and detailed guidance to participants about how to properly make beneficiary designations under the 401(k) plan to facilitate this process.

• Litigation related to a 401(k) plan participant’s account balance should be avoided at all costs, so it is critical that both plan administrators and plan participants take proper steps to avoid confusion and competing claims in the 401(k) plan account in connection with a participant’s death.