1st Oct 2013
An individual should review his or her estate planning any time there is a significant change in his or her family or financial situation. This includes not only the Will, Revocable Living Trust and Powers of Attorney, but also beneficiary designations. The case below teaches us an important lesson—failing to review and update your estate planning can have significant, unintended consequences.
Warren, a federal employee and Virginia resident, was married to Judy in 1996.1 As a federal employee, Warren received a life insurance policy under the Federal Employees’ Group Life Insurance Act of 1954 (FEGLIA). Judy was named as the beneficiary of Warren’s policy. Warren and Judy divorced in 1998 and Warren then married Jacqueline in 2002, but failed to update the beneficiary designation on the FEGLIA policy after the divorce and his second marriage. Warren died in 2008 and Judy filed a claim for the insurance proceeds and collected $124,558.03. A battle over the life insurance proceeds ensued between Judy and Jacqueline.
State vs. Federal Law
The conflict arose because a Virginia statute revokes a beneficiary designation in any contract that provides a death benefit to a former spouse where there has been a change in the decedent’s marital status.2 State laws often provide that spouses named as beneficiaries on insurance policies, retirement accounts or in Will or Trust documents are to be treated as having predeceased the owner if the parties are divorced. In other words, once the divorce was final, in the eyes of the state of Virginia for purposes of Warren’s assets, Judy had died before Warren.
However, FEGLIA specifies an “order of precedence” providing that an employee’s death benefits accrue first to that beneficiary ahead of other potential recipients; specifically, the beneficiaries of the policy are to be (a) the beneficiary or beneficiaries designated by the employee in a signed and witnessed writing received before death (Judy), but if there is no designated beneficiary, then (b) the widow or widower of the employee (Jacqueline), but absent a widow or widower, then (c) the child or children of the employee and descendants of the deceased children, the parents of the employee or their survivors, the executor or administrator of the estate of the employee and last, to other next of kin.3
The United States Supreme Court held that FEGLIA creates a scheme that gives highest priority to an insured’s designated beneficiary and which underscores that the employee’s “right” of designation “cannot be waived or restricted.” Therefore, the state law is preempted by the federal law. Based on this decision, Warren’s ex-wife, Judy, was entitled to the life insurance proceeds and his widow, Jacqueline, and children received no benefit from the policy.
In Illinois, an ex-spouse is deemed to have predeceased the creator of a Will or Revocable Living Trust.4, 5 However, the Illinois laws do not affect the documents until the divorce is final; filing for divorce does not trigger the laws. Additionally, unlike designations in Wills, Revocable Living Trusts and Powers of Attorney, the designation of a spouse as beneficiary of a life insurance policy or an account is not automatically revoked upon divorce by the laws. For a detailed explanation of “Divorce and Your Estate Planning” please see the August 2013 Newsletter.
The Importance of Updating Your Beneficiaries
As Hillman shows us, updating your beneficiary designations is an essential part of your estate planning. It is a common misconception that the terms of a Will or Trust supersede a beneficiary designation or that a stand-alone document can overwrite all beneficiary designations. Rather, an insurance policy or account that has a living beneficiary designated will circumvent the probate process and the bank or insurance company will distribute the assets or proceeds to such beneficiaries without considering the decedent’s estate planning documents or requiring any court documents or approval. A beneficiary designation trumps any other form or document and the only thing that a stand-alone document accomplishes is that it virtually guarantees a legal battle between the beneficiaries of the asset and the estate.
The Hillman decision also exemplifies another benefit of using an Irrevocable Life Insurance Trust (ILIT) to own a life insurance policy. In addition to the estate tax, administration and asset protection benefits of an ILIT, a properly drafted ILIT should provide that upon the filing of a divorce, the spouse shall be treated as having predeceased the insured individual. Had Warren’s life insurance policy been owned by an ILIT rather than in his own name, his ex-wife would not have received any of the benefits from the policy upon his death. For a detailed explanation of “Estate Planning with Life Insurance” please see the May 2012 Newsletter.
Reviewing and updating beneficiary designations on your life insurance policies and accounts is an integral part of the estate planning process. Maintaining an up-to-date list of your accounts and assets is the best way to stay organized for yourself and your beneficiaries. In addition to asset location, ownership information and account numbers, it is important to indicate who the designated beneficiaries are, if any. Typically, retirement accounts and life insurance policies require the owner to designate one or more beneficiaries when opening the account or purchasing the policy.
If your estate planning attorney has not advised you on how to designate such beneficiaries, it is important to contact an experienced estate planning attorney who can advise you on the proper beneficiary designations for each asset. As Warren’s situation clearly demonstrates, this is a crucial step in the estate planning process.
1. Hillman v. Maretta, 133 S. Ct. 1943, 186 L. Ed. 2d 43 (2013).
2. Va. Code Ann. §20-111.1(A).
3. 5 U.S.C. §8705(a).
4. 755 ILCS 5/4-7(b) – Dissolution of marriage or declaration of invalidity of the marriage of the testator revokes every legacy or interest or power of appointment given to or nomination to fiduciary office of the testator’s former spouse in a will executed before the entry of the judgment of dissolution of marriage or declaration of invalidity of marriage and the will takes effect in the same manner as if the former spouse had died before the testator.
5. 760 ILCS 35/1(a) – Judicial termination of the marriage of the settlor of a trust revokes every provision which is revocable by the settlor pertaining to the settlor’s former spouse in a trust instrument or amendment thereto executed by the settlor before the entry of the judgment of judicial termination of the settlor’s marriage, and any such trust shall be administered and construed as if the settlor’s former spouse had died upon entry of the judgment of judicial termination of the settlor’s marriage.