Why a poorly drafted spousal waiver can ruin a financial plan

The 8th Circuit Court of Appeals ruled that a surviving spouse's promise to waive her rights to her husband's 401(k) funds by signing a postnuptial agreement was invalid because the agreement was written incorrectly. As a result, she didn't waive her rights and inherited the money that was supposed to be paid to her husband's parents. (MidAmerican Pension and Employee Benefits Plans Administrative Committee v. Michael G. Cox, Sr., et al., No. 12-3563, U.S. Court of Appeals, 8th Circuit, July 12, 2013)

Michael Cox worked for MidAmerican Energy Corporation and participated in the "MEC 401(k)." Between 1997 and 2004, Michael and Kathy Cox had been twice married and divorced. In September 2004, while he was single, Michael named his parents as the beneficiaries of his MEC 401(k). Afterwards, in 2010, Michael and Kathy remarried each other for the third time!

Before the third marriage however, the couple signed a prenuptial agreement. Apparently, for some reason they had some concerns about whether the marriage was going to last. To the couple's credit, or perhaps to that of their advisors, they knew that a prenuptial agreement could not be used to waive spousal rights in a 401(k) plan (only a spouse can waive those rights). So, three weeks after they were remarried, they re-executed the same prenuptial agreement on March 26, 2010. At this point the prenuptial agreement was now a postnuptial agreement.

The agreement said that, in the event the marriage ended, they each waived their rights to each other's property. With respect to Michaels's 401(k), the agreement specifically stated that Michael's 401(k) would remain his, and that Kathy disclaimed all rights to it, and agreed not to seek a qualified domestic relations order (QDRO) in a future divorce with respect to the 401(k) plan.

The postnuptial agreement also addressed Kathy's rights under ERISA (Employee Retirement Income Security Act) as a surviving spouse beneficiary of Michael's 401(k). It said that Kathy irrevocably consented to any change in beneficiary or form of benefit payments, without requiring her further consent. It also said she agreed to consent, in writing, to waive her rights to his retirement assets at any time.

A little over a year after their third remarriage, Michael filed for divorce on May 4, 2011. The divorce documents referenced the postnuptial agreement he and Kathy had signed, and requested that their property be divided according to it. However, Michael died seven days later on May 11, 2011, before the divorce was finalized. At the time his most recent marriage to Kathy had been for more than one year.

After his death Michael's parents and Kathy argued over who should receive the 401(k) funds. The 401(k) plan administrator believed the parents should get the money and sent Kathy a letter to sign a waiver to any rights in the 401(k) plan. She refused to sign that waiver. The plan administrator then filed an "interpleader" action in which it asked the Court to decide who should get the money.

The District Court ruled that the postnuptial agreement was not effective to waive Kathy's rights to the 401(k) funds. Despite the various provisions of the agreement, Kathy never acknowledged the effect of signing a waiver, which is required under ERISA. As a result, the Court said Kathy didn't properly waive her rights to Michael's 401(k) and awarded the funds to her as his surviving spouse. Michael's parents disagreed with that, so they appealed the decision, but lost there as well.

In analyzing the case, the Court of Appeals said that ERISA governs the distribution of Michael's 401(k) plan. Under ERISA, surviving spouses are automatically entitled to retirement benefits. However, a married plan participant can name someone other than his spouse as the beneficiary, but only if many strict rules under ERISA are met.

The Court said the agreement did not meet the strict acknowledgement rules of ERISA because it failed to inform Kathy, in clear terms, that she had a right to receive the 401(k) funds and that she was waiving that right. Those ERISA rules are intended to protect spouses against the risk of unknowingly waiving their rights. The agreement (which the Court refers to as an "antenuptial agreement") failed to include an acknowledgement of the effect of the waiver. In other words, the agreement failed to make clear that, by executing a waiver, Kathy would not receive the retirement funds that she would otherwise be entitled to. Because the agreement wasn't written properly, the soon-to-be-but-not-yet ex-wife got everything.

In hindsight, rather than executing a postnuptial agreement, Michael and Kathy probably should have executed the 401(k)'s own documents for Kathy to waive her spousal rights. This would have cost them nothing and those documents were very likely written correctly and would have properly waived Kathy' rights to Michael's 401(k), as they had intended to do.

Postnuptial agreements can waive spousal benefits, but only if the agreement meets the strict requirements of ERISA.

Advisor takeaway: Suggest that clients think long and hard before marrying the same person for a third time!

For more from Ed Slott, see:

The little mistake that could destroy a life insurance plan