The purpose of a 401(k) account is to accumulate money for your retirement. When you first open the account, you’ll be asked by the plan administrator to fill out a declaration naming primary and contingent beneficiaries. Although it’s possible for a contingent beneficiary to contest the 401(k) payments to primary beneficiaries, the legal challenges must be substantial before a court will intervene.
Contingent beneficiaries might be able to contest a 401(k) primary beneficiary if they can demonstrate fraud, undue influence, forgery or some other wrongdoing.
Primary Beneficiary 401(k)
The primary beneficiaries of a 401(k) account inherit the account’s assets when the account owner dies. In most cases, the primary beneficiary will be the owner’s spouse, if one exists. In fact, 401(k) spouse beneficiary rules require that the proceeds from a 401(k) be solely inherited by a spouse unless the spouse gives written permission for some other arrangement. Should the spouse agree, the account owner can add additional primary beneficiaries or simply name someone other than the spouse to inherit the account assets. Without the agreement, the spouse is entitled to the full inheritance even if the beneficiary documents say otherwise.
Contingent Beneficiary 401(k)
The 401(k) account owner has the opportunity to name one or more contingent beneficiaries who would inherit the account if the primary beneficiaries predecease the owner. Unless explicitly stated otherwise on the beneficiary document, multiple beneficiaries share equally in the distribution of the 401(k) account.
Transfer-on-Death Assets on a 401(k) Account
A 401(k) account contains “transfer on death” (TOD) assets, meaning that the assets are distributed to the named beneficiaries upon the death of the account owner without the need for probate, a court proceeding in which a judge determines how an estate will be distributed. The significance of the TOD provision is that a will or trust document cannot override a properly specified 401(k) beneficiary declaration. To contest a primary beneficiary, a contingent beneficiary of a 401(k) account must be able to prove to the probate judge that the beneficiary declaration is defective. A 401(k) might also enter probate if it names an illegal beneficiary, such as a pet, or fails to name any beneficiaries. Normally, only a beneficiary (primary or contingent) can contest the disposition of a 401(k) account.
Contesting a Primary Beneficiary
A contingent beneficiary can contest the disposition of a 401(k) by showing the court that an illegal act has occurred, such as:
Undue influence: This can occur if the account owner is susceptible to pressure or influence by a person who wishes to have the 401(k)’s disposition changed, usually to favor the influencer at the expense of someone else. The word “undue” is key in showing that the influence was illegal. For example, influence might be undue if the account owner is suffering dementia or it arises from blackmail or threat of harm. Medical records might cast light on an account owner’s diminished faculties, but proving something more nefarious can be extremely difficult.
Forgery: Any change in beneficiary must be stated in writing on the official beneficiary document, signed by the account owner. Proving that the owner’s signature on the beneficiary document was forged is a strong basis for contesting the distribution of a 401(k). When a spouse signs away the right for an exclusive claim on a 401(k) inheritance, that signature must be notarized by law.
Fraud: All sorts of fraud are possible. Lawyers or plan administrators might work alone or with other individuals to illegally change the retirement beneficiary declarations. A fraudster might trick an account owner into changing beneficiaries by lying about some benefit for doing so. Fraud schemes are limited only by one’s imagination.
Some beneficiary problems can occur that don’t allow for court review. For example, if a 401(k) account owner divorces the primary beneficiary but fails to redesignate beneficiaries, the ex-spouse would be entitled to inherit the account, assuming no fraud has occurred. However, if the divorced account owner remarried, the new spouse would be entitled to inherit the account because that right had not been signed away, notwithstanding the beneficiary declaration. Of course, the ex-spouse might insist on challenging the distribution in court, and the probate judge would be the ultimate arbiter of the dispute.
Predeceased Primary Beneficiary
If a sole 401(k) primary beneficiary dies before the account owner, the contingent beneficiaries would lay claim to the account assets on the owner’s demise. A more complex situation exists if multiple primary beneficiaries are named but they do not all predecease the account owner. Normally, a contingent beneficiary can only inherit the account if all primary beneficiaries die first, a situation known as “per capita” distribution, which is the default distribution method for retirement accounts.
For example, suppose a widowed 401(k) owner designates her three sons to equally share distribution of her account when she dies. Furthermore, suppose the eldest’s son’s will specifies that his estate is divided equally between his two children. Now, suppose the eldest child predeceases his mother but she fails to revise the beneficiary document before she dies. Under per capita rules, her two remaining sons would equally share the account assets. However, if the account owner had specified “per stirpes” distribution on the beneficiary form, the two living children would each receive one-third of the assets, and the last third would be distributed equally to the predeceased son’s two children (the account owner’s grandchildren). In either case, the contingent beneficiaries receive nothing.
This scenario might be ripe for a legal challenge. For instance, suppose the 401(k) plan documents specify that per stirpes distribution would be assumed instead of the conventional per capita distribution. The two remaining children might make a case that their mother didn’t understand this provision and didn’t want per stirpes distribution to occur. A probate judge might or might not consider this sufficient basis for contesting the distribution.
Tax Issues for Beneficiaries
Beneficiaries of a 401(k) must pay taxes on any inherited untaxed amounts, i.e., amounts arising from tax-deferred contributions and the earnings on those contributions. Even if the deceased account holder died before age 59 ½, the beneficiaries would not be subject to the 10 percent early withdrawal penalty. Taxed contributions, such as ones made to a Roth 401(k) account, can pass through tax-free to beneficiaries. However, if a Roth account is less than five years old when the owner dies, beneficiaries might have to pay tax and the 10 percent penalty on inherited earnings but not contributions.
The tax rules for an inherited 401(k) specify the period in which the assets must be distributed to beneficiaries, as this determines how quickly the distribution will be taxed. Spouses have several options. If you and your deceased spouse were both older than 70 ½ at the time of death, you must continue taking required minimum distributions. You can keep the money in your spouse’s 401(k), roll it over to your own IRA or roll it over to an inherited IRA. With IRA rollovers, required minimum distributions are based on your life expectancy. If you are between age 59 ½ and 70 ½, you can postpone required minimum distributions by rolling the 401(k) into your own IRA. If you are younger than 59 ½, you can take withdrawals without triggering the 10 percent early withdrawal penalty.
A non-spouse retirement beneficiary must observe different rules that mandate either required minimum distributions or a five-year distribution period. If the account owner was less than 70 ½, you can take the required minimum distributions based on your life expectancy rather than the life expectancy of the owner at the time of death.