Non-employee Spouse Waivers of ERISA Plan Benefits Not Reliable

A Case in Point

Take the case of William and Liv Kennedy. William was employed by DuPont, and in the course of his employment accumulated interests in several employee benefit plans. In their marital settlement agreement, incorporated into the divorce decree, Liv Kennedy agreed to be divested of “all right, title, interests, and claim in and to ' the proceeds therefrom, and any other rights related to any ' retirement plan,” except as provided in the decree. A QDRO was prepared transferring to Liv the agreed interests in William's retirement plans, except for one such plan (the SIP plan), the right to which William retained. In this plan, William had designated Liv as the beneficiary of the death benefit, a designation which he did not change after the divorce and prior to his death seven years later. Liv claimed and was paid the death benefit, approximately $400,000, from this plan. Their daughter, the executrix of William's estate, asserted that Liv had waived her right to the death benefit in the divorce agreement, and also claimed this benefit for his estate. This much litigated question has now reached the Supreme Court. Kennedy v. Plan Adm'r for DuPont Sav. & Inv. Plan, 497 F.3d 426 (5th Cir. 2007), cert. granted, 128 S.Ct. 1225 (2008).

William could have changed the beneficiary designation, once the divorce was final, but he just did not do it. The QDRO did not refer to this plan, and William may have believed that it was not necessary for him to make any change. A Texas statute did provide that the waiver in the decree would override the beneficiary designation in the plan unless William specifically “redesignated” Liv as the beneficiary. Such statutes, however, are preempted by ERISA. Egelhoff v. Egelhoff, 532 U.S. 141 (2001). Although state law cannot help William's successors in a case like this, some courts of appeals have held that federal common law applies to fill a “gap” in the law as applied to waivers. See Estate of Altobelli v. Int'l Bus. Mach. Corp., 77 F.3d 78 (4th Cir. 1996); Fox Valley & Vicinity Constr. Workers Pension Fund v. Brown, 897 F.2d 275 (7th Cir. 1990) (en banc) (representing the “majority rule”). In creating federal common law, Fox Valley and similar cases drew on the underlying state law principles, so the waiver issue was resolved in much the same way as it would have been resolved by applying local law. The federal district court in Kennedy was persuaded by these cases, and concluded that Liv's waiver was effective to override the beneficiary designation in the plan. The Fifth U.S. Circuit Court of Appeals reversed, finding that the “waiver” was an indirect transfer of Liv's interest as a beneficiary which was prohibited by the anti-assignment rule. In its view, the only exception to that rule would be a transfer pursuant to a QDRO. The Supreme Court granted certiorari specifically to consider that question.

Analysis

The Court's focus on whether a waiver is effective only if made through a QDRO raises some interesting questions. Presumably, this issue is significant only in cases where an existing beneficiary designation is not changed by the Participant because once the divorce is final, the non-participant now ex-spouse is no longer protected by the spousal protections built in to ERISA. Consequently, William could simply revoke the beneficiary designation. As simple as this might sound, the employee spouse, and perhaps that spouse's advisers, may have focused on what is to be transferred, and the proper handling of interests to be retained may then be overlooked. Kennedy does demonstrate the importance of decisions about how to deal with interests retained by the employee spouse. Moreover, the use of a QDRO to protect a retained interest from later events seems misplaced, as the QDRO specifically applies to a transfer to a person ' the “alternate payee” ' other than the employee spouse. The facts in this case, involving litigation between a mother and her daughter acting as the executrix of the estate of her father, do raise some questions as to what William might have really intended, emphasizing the importance of dealing explicitly with the retained interest. In other cases, the presence of a subsequent spouse, the children of a previous marriage or an interested parent, as in Fox Valley, raises the stakes. Beneficiary designations are important, even when disavowed by a divorcing spouse, and cannot be neglected.

One should note that Liv's interest in Kennedy was the death benefit in a pension plan. The anti-assignment rule expressly applies to pension plans. ERISA ' 206(d)(1), 29 US.C.
' 1056(d)(1); Boggs v. Boggs, 530 U.S. 833 (1997), holding that the testamentary transfer by a non-participant spouse of an interest in a qualified employee benefit plan under state community property law was preempted by ERISA and thus prohibited by the anti-assignment rule. In contrast, welfare benefit plans such as group term life insurance plans, which are also governed by ERISA, are not subject to the anti-assignment rule. In divorce this distinction may be important because group life insurance provided as an employee benefit may also be a significant element in divorce settlements. Since interests in welfare benefit plans are “freely alienable,” a waiver in a divorce agreement may be effective to override a beneficiary designation which the participant insured employee has not changed following divorce, at least in the majority of circuits that invoke federal common law to resolve that question. See the opinion of the court of appeals in Kennedy, supra, distinguishing the Fifth Circuit decisions that rely on federal common law on that ground; Altobelli, supra. Resolution of the issue in Kennedy, however, may override these cases as well, if the Court concludes that ERISA's command that the fiduciary administer the plan “in accordance with the documents ' governing the plan,” ERISA ' 404(a)(1)(D), 29 U.S.C. ' 1104(a)(1)(D), prevents application of provisions found only in divorce documents, other than a QDRO. Cases holding that the plan fiduciary must honor the designation of the beneficiary under the plan rely on this reasoning. See Krishna v. Colgate Palmolive Co., 7 F.3d 11 (2nd Cir. 1993); Hallinby v. Hallinby, 541 F.Supp. 2d 591 (S.D.N.Y. .2008). Application of this reasoning undermines the waiver cases and could prevent application of divorce waivers even in the life insurance cases.

Another Situation

In most of the cases, divorce occurred before the employee retired. What would happen if the employee retired and elected the qualified joint and survivor annuity as his or her benefit under the pension plan, naming the then current spouse as the beneficiary? The amount of the annuity would, of course, depend on the relative ages of the participant and his or her spouse, and once determined, could not be changed. Then, the parties divorce, and the participant decides to change the beneficiary of the survivor benefit to his or her new spouse. As with other financial aspects of the parties' assets, one might think this should be a negotiated element in a marital settlement. See, e.g., Hallanby, supra. This precise issue was raised in McGowan v. NJR Serv. Corp., 423 F.3d 241 (3d Cir. 2005), cert. denied, 127 S.Ct. 1118 (2007).

James was married to Rosemary, his second wife, when he retired and elected the qualified joint and survivor annuity (100% during his life, 50% to his beneficiary for her life if she survives him), naming Rosemary the beneficiary of the survivor annuity. Shortly thereafter James and Rosemary divorced. Their agreement provided that Rosemary “waives ' any right to ' [James'] pension plan.” James then sought to revoke the designation of Rosemary as the beneficiary of the survivor annuity in his interest under his employer's pension plan, initially in favor his first wife Shirley, and subsequently in favor of his third wife Donna. The plan fiduciary refused to comply, and James brought suit under ERISA ' 502(a)(1)(B) to require the fiduciary to recognize Rosemary's waiver in the divorce agreement. He lost both in the district court and on appeal, with the court of appeals joining the “minority view” on the relevance of federal common law in resolving this question.

McGowan is particularly interesting because it produced three opinions. Two opinions agreed that state law was preempted, that the waiver in the divorce agreement was an attempted assignment within the meaning of the anti-assignment clause as interpreted by the Court in Boggs, and, therefore, that it did not have any effect. The dissenting opinion would give effect to the terms of the divorce agreement if found to be an effective waiver, but was puzzled by what would then have followed. The plan provided that the designation of Rosemary as the beneficiary of the survivor annuity was irrevocable, the amount of the annuity having been determined with reference to her as the survivor. The dissenter seemed to concur that Donna could not be substituted for Rosemary, even if her interest was limited by Rosemary's life.

It might seem strange in a cases like McGowan and Hallinby, where the participant's benefit is in pay status, that the participant could not force a shift in the survivor benefit away from a divorcing spouse and in favor of the participant's current spouse. Apart from the interest of the plan in finally determining the benefit to be paid to the participant, however, the beneficiary spouse's interest could also be viewed as an earned interest. Applying ERISA to this benefit to prevent the participant from assigning to someone else could properly be seen as recognition of its earned character. Negotiation of a divorce settlement should then take this element into account as value retained by the non-employee spouse, with adjustment in the division of other assets to reflect that fact. Not doing so, whatever the non-employee spouse might agree to, would seem to invite prolonging the marital dispute.

Conclusion

In any event, the Court has taken up these questions by agreeing to hear argument in Kennedy. Probably, in light of the continuing litigation over waivers in divorce agreements, it saw its work in Egelhoff and Boggs as unfinished. Given recent decisions on the preemptive force of ERISA, cf. Aetna Health, Inc. v. Davilla, 542 U.S. 200 (2004), one might expect to find that agreements to relinquish beneficiary interests in a spouse's pension or other employee benefit plan, absent a QDRO, will not have the intended effect. Caution is advised, but stay tuned, further developments are anticipated.

Thomas R. White, 3rd, a member of this newsletter's Board of Editors, is a John C. Stennis Professor of Law at the University of Virginia Law School.

In an aging population, accumulations in employee retirement plans assume greater and greater importance. Nowhere is this more true than in divorce, when, for many couples, retirement savings represent the most significant part of their savings. This fact is reflected in divorce practice by the number of firms that specialize in valuing accounts in employee benefit plans subject to the Employee Retirement Income Security Act (ERISA) and in drafting domestic relations orders for recognition as “qualified domestic relations orders” (QDROs). For divorcing couples who receive professional advice on this question, the division of retirement savings may seem straight forward, but for some who may not have the benefit of such advice, this can prove to be difficult, even when the parties have reached agreement on how the funds should be divided.

Pension Funds

A pension fund, such as, for example, a 401(k) plan, must include an anti-assignment clause, preventing the transfer or assignment of the participant's interest in the plan. I.R.C. ' 401(a)(13); ERISA ' 206(d)(1), 29 U.S.C. ' 1056(d)(1). Moreover, under the Retirement Equity Act amendments to ERISA, the participant's spouse may also have rights as a beneficiary in the participant's interest in the plan, and his or her consent may be required to make or change beneficiary designations. See IRC ' 401(a)(11); ERISA ' 205, 29 U.S.C. ' 1055. The one exception to the anti-assignment rule is the QDRO, which can be used to assign an interest in a retirement fund to the spouse who is not the employee and, therefore, not the participant in the plan. But what about the interest retained by the employee? This problem often appears when the employee spouse dies, sometimes long after the divorce, and his or her ex-spouse then claims the death benefit, contrary to the marital agreement the parties had at the time of divorce.

A Case in Point

Take the case of William and Liv Kennedy. William was employed by DuPont, and in the course of his employment accumulated interests in several employee benefit plans. In their marital settlement agreement, incorporated into the divorce decree, Liv Kennedy agreed to be divested of “all right, title, interests, and claim in and to ' the proceeds therefrom, and any other rights related to any ' retirement plan,” except as provided in the decree. A QDRO was prepared transferring to Liv the agreed interests in William's retirement plans, except for one such plan (the SIP plan), the right to which William retained. In this plan, William had designated Liv as the beneficiary of the death benefit, a designation which he did not change after the divorce and prior to his death seven years later. Liv claimed and was paid the death benefit, approximately $400,000, from this plan. Their daughter, the executrix of William's estate, asserted that Liv had waived her right to the death benefit in the divorce agreement, and also claimed this benefit for his estate. This much litigated question has now reached the Supreme Court. Kennedy v. Plan Adm'r for DuPont Sav. & Inv. Plan , 497 F.3d 426 (5th Cir. 2007), cert. granted, 128 S.Ct. 1225 (2008).

William could have changed the beneficiary designation, once the divorce was final, but he just did not do it. The QDRO did not refer to this plan, and William may have believed that it was not necessary for him to make any change. A Texas statute did provide that the waiver in the decree would override the beneficiary designation in the plan unless William specifically “redesignated” Liv as the beneficiary. Such statutes, however, are preempted by ERISA. Egelhoff v. Egelhoff , 532 U.S. 141 (2001). Although state law cannot help William's successors in a case like this, some courts of appeals have held that federal common law applies to fill a “gap” in the law as applied to waivers. See Estate of Altobelli v. Int'l Bus. Mach. Corp. , 77 F.3d 78 (4th Cir. 1996); Fox Valley & Vicinity Constr. Workers Pension Fund v. Brown , 897 F.2d 275 (7th Cir. 1990) (en banc) (representing the “majority rule”). In creating federal common law, Fox Valley and similar cases drew on the underlying state law principles, so the waiver issue was resolved in much the same way as it would have been resolved by applying local law. The federal district court in Kennedy was persuaded by these cases, and concluded that Liv's waiver was effective to override the beneficiary designation in the plan. The Fifth U.S. Circuit Court of Appeals reversed, finding that the “waiver” was an indirect transfer of Liv's interest as a beneficiary which was prohibited by the anti-assignment rule. In its view, the only exception to that rule would be a transfer pursuant to a QDRO. The Supreme Court granted certiorari specifically to consider that question.

Analysis

The Court's focus on whether a waiver is effective only if made through a QDRO raises some interesting questions. Presumably, this issue is significant only in cases where an existing beneficiary designation is not changed by the Participant because once the divorce is final, the non-participant now ex-spouse is no longer protected by the spousal protections built in to ERISA. Consequently, William could simply revoke the beneficiary designation. As simple as this might sound, the employee spouse, and perhaps that spouse's advisers, may have focused on what is to be transferred, and the proper handling of interests to be retained may then be overlooked. Kennedy does demonstrate the importance of decisions about how to deal with interests retained by the employee spouse. Moreover, the use of a QDRO to protect a retained interest from later events seems misplaced, as the QDRO specifically applies to a transfer to a person ' the “alternate payee” ' other than the employee spouse. The facts in this case, involving litigation between a mother and her daughter acting as the executrix of the estate of her father, do raise some questions as to what William might have really intended, emphasizing the importance of dealing explicitly with the retained interest. In other cases, the presence of a subsequent spouse, the children of a previous marriage or an interested parent, as in Fox Valley, raises the stakes. Beneficiary designations are important, even when disavowed by a divorcing spouse, and cannot be neglected.

One should note that Liv's interest in Kennedy was the death benefit in a pension plan. The anti-assignment rule expressly applies to pension plans. ERISA ' 206(d)(1), 29 US.C.
' 1056(d)(1); Boggs v. Boggs , 530 U.S. 833 (1997), holding that the testamentary transfer by a non-participant spouse of an interest in a qualified employee benefit plan under state community property law was preempted by ERISA and thus prohibited by the anti-assignment rule. In contrast, welfare benefit plans such as group term life insurance plans, which are also governed by ERISA, are not subject to the anti-assignment rule. In divorce this distinction may be important because group life insurance provided as an employee benefit may also be a significant element in divorce settlements. Since interests in welfare benefit plans are “freely alienable,” a waiver in a divorce agreement may be effective to override a beneficiary designation which the participant insured employee has not changed following divorce, at least in the majority of circuits that invoke federal common law to resolve that question. See the opinion of the court of appeals in Kennedy, supra, distinguishing the Fifth Circuit decisions that rely on federal common law on that ground; Altobelli, supra. Resolution of the issue in Kennedy, however, may override these cases as well, if the Court concludes that ERISA's command that the fiduciary administer the plan “in accordance with the documents ' governing the plan,” ERISA ' 404(a)(1)(D), 29 U.S.C. ' 1104(a)(1)(D), prevents application of provisions found only in divorce documents, other than a QDRO. Cases holding that the plan fiduciary must honor the designation of the beneficiary under the plan rely on this reasoning. See Krishna v. Colgate Palmolive Co. , 7 F.3d 11 (2nd Cir. 1993); Hallinby v. Hallinby , 541 F.Supp. 2d 591 (S.D.N.Y. .2008). Application of this reasoning undermines the waiver cases and could prevent application of divorce waivers even in the life insurance cases.

Another Situation

In most of the cases, divorce occurred before the employee retired. What would happen if the employee retired and elected the qualified joint and survivor annuity as his or her benefit under the pension plan, naming the then current spouse as the beneficiary? The amount of the annuity would, of course, depend on the relative ages of the participant and his or her spouse, and once determined, could not be changed. Then, the parties divorce, and the participant decides to change the beneficiary of the survivor benefit to his or her new spouse. As with other financial aspects of the parties' assets, one might think this should be a negotiated element in a marital settlement. See, e.g., Hallanby, supra. This precise issue was raised in McGowan v. NJR Serv. Corp. , 423 F.3d 241 (3d Cir. 2005), cert. denied, 127 S.Ct. 1118 (2007).

James was married to Rosemary, his second wife, when he retired and elected the qualified joint and survivor annuity (100% during his life, 50% to his beneficiary for her life if she survives him), naming Rosemary the beneficiary of the survivor annuity. Shortly thereafter James and Rosemary divorced. Their agreement provided that Rosemary “waives ' any right to ' [James'] pension plan.” James then sought to revoke the designation of Rosemary as the beneficiary of the survivor annuity in his interest under his employer's pension plan, initially in favor his first wife Shirley, and subsequently in favor of his third wife Donna. The plan fiduciary refused to comply, and James brought suit under ERISA ' 502(a)(1)(B) to require the fiduciary to recognize Rosemary's waiver in the divorce agreement. He lost both in the district court and on appeal, with the court of appeals joining the “minority view” on the relevance of federal common law in resolving this question.

McGowan is particularly interesting because it produced three opinions. Two opinions agreed that state law was preempted, that the waiver in the divorce agreement was an attempted assignment within the meaning of the anti-assignment clause as interpreted by the Court in Boggs, and, therefore, that it did not have any effect. The dissenting opinion would give effect to the terms of the divorce agreement if found to be an effective waiver, but was puzzled by what would then have followed. The plan provided that the designation of Rosemary as the beneficiary of the survivor annuity was irrevocable, the amount of the annuity having been determined with reference to her as the survivor. The dissenter seemed to concur that Donna could not be substituted for Rosemary, even if her interest was limited by Rosemary's life.

It might seem strange in a cases like McGowan and Hallinby, where the participant's benefit is in pay status, that the participant could not force a shift in the survivor benefit away from a divorcing spouse and in favor of the participant's current spouse. Apart from the interest of the plan in finally determining the benefit to be paid to the participant, however, the beneficiary spouse's interest could also be viewed as an earned interest. Applying ERISA to this benefit to prevent the participant from assigning to someone else could properly be seen as recognition of its earned character. Negotiation of a divorce settlement should then take this element into account as value retained by the non-employee spouse, with adjustment in the division of other assets to reflect that fact. Not doing so, whatever the non-employee spouse might agree to, would seem to invite prolonging the marital dispute.

Conclusion

In any event, the Court has taken up these questions by agreeing to hear argument in Kennedy. Probably, in light of the continuing litigation over waivers in divorce agreements, it saw its work in Egelhoff and Boggs as unfinished. Given recent decisions on the preemptive force of ERISA, cf. Aetna Health, Inc. v. Davilla , 542 U.S. 200 (2004), one might expect to find that agreements to relinquish beneficiary interests in a spouse's pension or other employee benefit plan, absent a QDRO, will not have the intended effect. Caution is advised, but stay tuned, further developments are anticipated.

Thomas R. White, 3rd, a member of this newsletter's Board of Editors, is a John C. Stennis Professor of Law at the University of Virginia Law School.