Preparing for the Unthinkable: Treatment of Compensation and Benefits on Death of an Employee
When an employee unexpectedly dies, companies often want to act quickly so as to minimize disruption to the deceased employee’s family. While that is an important goal, companies need to ensure that they follow federal and state requirements applicable to the distribution of final wages, vested equity awards, retirement plan balances and other benefits on the death of an employee. This article provides a high-level overview of the considerations that apply when a company needs to wind up the affairs of a deceased employee.
Should an Employer Request Evidence of the Employee’s Death?
Yes. Requesting proof of an employee’s death, while potentially sensitive, is a crucial step for employers. Firstly, this document provides official and legal verification of the employee’s passing. This is critical for protecting the employer from potential fraudulent claims and ensures that any actions taken regarding the employee’s employment and benefits are based on factual information. Secondly, the death certificate is often a required document for initiating the necessary procedures for life insurance payouts, retirement fund distributions, and other applicable benefits. Therefore, while the conversation may be uncomfortable, by obtaining this official documentation, employers can ensure they are fulfilling their obligations and proceeding responsibly in managing the final affairs related to the deceased employee’s employment.
Who Should Receive the Deceased Employee’s Compensation and Benefits?
It is critical that companies do not simply distribute compensation and benefits to the deceased employee’s spouse or next-of-kin and, instead, that they distribute the compensation and benefits to the deceased’s designated beneficiaries. If no beneficiary is named or if the named beneficiary is deceased, benefits will be payable to the employee’s estate. As discussed further below, when a will exists, employers must await the issuance of Letters Testamentary before distributing benefits according to the will’s instructions. In the absence of a will, the appointment of an estate administrator by the court is necessary before benefits can be distributed according to state intestacy laws. If a company fails to distribute the compensation and benefits appropriately, they could face claims by the deceased’s employee estate for unauthorized payments.
What Is a Beneficiary Designation Form?
An employee uses a beneficiary designation form to identify the individuals they would like to receive their compensation and benefits should they die. In our experience, most startup companies do not use beneficiary designation forms for wages or equity awards, but they may use beneficiary designation forms for 401(k) plans, life insurance and other employee benefits.
While beneficiary designation forms may seem like a good idea because then an employer has clear instructions on how to handle a deceased employee’s compensation and benefits, they are an administrative burden for employers and require the employer to periodically remind employees to update their forms. As the forms are often not updated by employees to reflect a change in status—such as a marriage, divorce or the birth of a child—employers that follow beneficiary designation forms may end up transferring the deceased employee’s compensation and benefits to someone who is not legally entitled to them, which could expose the employer to risk. In the absence of a beneficiary designation, the deceased employee’s compensation and benefits will pass to the employee’s estate, necessitating legal proceedings through the court.
How are Compensation and Benefits Distributed If the Deceased Employee Has No Named Beneficiaries or Predeceased Named Beneficiaries?
Upon the death of an employee, the legal proceedings for distributing their final compensation and benefits (if there is no named beneficiary or a named beneficiary predeceases) differ significantly depending on whether they had a valid will. If the employee died testate (i.e., with a will), the process involves probate, where the will is validated by the court, and the named executor is granted Letters Testamentary to manage the estate, pay debts and taxes, and then distribute the remaining assets according to the will’s instructions, including any benefits from the employer. Conversely, if the employee died intestate (i.e., without a will), the court appoints an administrator who receives Letters of Administration and is responsible for inventorying assets, paying debts and taxes, and then distributing the remaining assets, including employer-held benefits, to the legal heirs as determined by the state’s intestacy laws. In both cases, court involvement is necessary to legally authorize the transfer of the deceased employee’s assets, although the presence of a will provides a predetermined roadmap for distribution, while intestacy requires the court to apply statutory rules of inheritance.
Can Final Wages Be Paid to the Deceased Employee’s Bank Account?
No. The deceased employee’s final wages should not be paid to their bank account, but should, instead, be paid to their beneficiary identified in the beneficiary designation form (if there is one) or to their estate in accordance with state laws. Final wages include an employee’s annual salary, accrued but unused paid time-off and accrued but unpaid bonuses or commissions. Special tax-withholding rules apply depending on when the final wages are paid, and employers should coordinate with their payroll providers to ensure that they comply with these rules.
How are a Deceased Employee’s Equity Awards Treated?
In general, equity incentive plans provide that, on a termination due to death, employees forfeit unvested equity awards—such as restricted stock, stock options and restricted stock units—but that employees retain their vested equity awards. In the case of stock options, on a termination due to death, the employee’s estate will often have up to 12 months following termination to exercise the vested options. This longer time period can come in handy because the probate process can often take months. Additionally, vested stock options can be exercised by the employee’s estate on death. In certain limited circumstances, the vesting of all or a portion of an employee’s equity award may accelerate on a termination due to death, so it is important that a company carefully check their equity plan documents and the deceased employee’s offer letter or employment agreement to ensure that they honor the deceased employee’s contractual entitlements.
How Are a Deceased Employee’s Retirement Plan Benefits Treated?
A company should carefully review their 401(k) plan documents to confirm (i) whether the deceased employee is fully vested in their 401(k) plan account balance and, if not, whether the plan provides for full vesting on death and (ii) whether the plan provides for an employer contribution and, if so, whether the eligibility requirements for the employer contributions are waived on death. (They often are.) The deceased employee’s spouse is the default beneficiary unless a signed waiver exists. Employers should work closely with their legal counsel and 401(k) plan provider or recordkeeper to ensure that the deceased employee’s 401(k) account balance is being distributed in accordance with the 401(k) plan terms and the beneficiary designation form (if there is one). In general, a beneficiary may keep the 401(k) account in the plan, roll over the account to another 401(k) plan or individual retirement account (IRA) or receive a distribution of the balance.
Are There Other Employee Benefits That May Be Triggered on Death?
Yes. A deceased employee’s dependents may be eligible for life insurance benefits and health care coverage under COBRA. When an employee dies, an employer should promptly notify their medical, dental, vision and life insurance providers and furnish them with a copy of the employee’s death certificate. The company should also provide the life insurance provider with a copy of any beneficiary designation forms. Additionally, the death of an employee is an event that entitles the deceased employee’s eligible dependents to health care coverage under COBRA for up to 36 months (as opposed to the regular 18 months) following death. Finally, a company should evaluate whether there are any other benefits—such as flexible spending accounts or health savings accounts—that will need to be addressed.
Are There Actions That Employers Can Take to Assist with Employee Estate Planning?
There are a number of ways employers can take meaningful actions to assist their employees with estate planning, including by offering educational workshops or seminars on the basics of estate planning. Providing employees with essential knowledge on foundational documents like a will can guide employees to direct the distribution of their assets and designate guardians for minor children, preventing potential complications and ensuring their wishes are honored. However, it is equally important to highlight that assets with beneficiary designations, such as life insurance policies and retirement accounts, will typically transfer directly to the named beneficiaries outside of probate. Ensuring these designations are accurately completed and kept up-to-date with life changes—like marriage, divorce, or the birth of a child—is paramount. By helping employees understand and manage both formal estate planning documents and beneficiary designations, employers can reduce potential administrative burdens and legal complications down the line.
Should an Employer Request Evidence of the Employee’s Death?
Yes. Requesting proof of an employee’s death, while potentially sensitive, is a crucial step for employers. Firstly, this document provides official and legal verification of the employee’s passing. This is critical for protecting the employer from potential fraudulent claims and ensures that any actions taken regarding the employee’s employment and benefits are based on factual information. Secondly, the death certificate is often a required document for initiating the necessary procedures for life insurance payouts, retirement fund distributions, and other applicable benefits. Therefore, while the conversation may be uncomfortable, by obtaining this official documentation, employers can ensure they are fulfilling their obligations and proceeding responsibly in managing the final affairs related to the deceased employee’s employment.
Who Should Receive the Deceased Employee’s Compensation and Benefits?
It is critical that companies do not simply distribute compensation and benefits to the deceased employee’s spouse or next-of-kin and, instead, that they distribute the compensation and benefits to the deceased’s designated beneficiaries. If no beneficiary is named or if the named beneficiary is deceased, benefits will be payable to the employee’s estate. As discussed further below, when a will exists, employers must await the issuance of Letters Testamentary before distributing benefits according to the will’s instructions. In the absence of a will, the appointment of an estate administrator by the court is necessary before benefits can be distributed according to state intestacy laws. If a company fails to distribute the compensation and benefits appropriately, they could face claims by the deceased’s employee estate for unauthorized payments.
What Is a Beneficiary Designation Form?
An employee uses a beneficiary designation form to identify the individuals they would like to receive their compensation and benefits should they die. In our experience, most startup companies do not use beneficiary designation forms for wages or equity awards, but they may use beneficiary designation forms for 401(k) plans, life insurance and other employee benefits.
While beneficiary designation forms may seem like a good idea because then an employer has clear instructions on how to handle a deceased employee’s compensation and benefits, they are an administrative burden for employers and require the employer to periodically remind employees to update their forms. As the forms are often not updated by employees to reflect a change in status—such as a marriage, divorce or the birth of a child—employers that follow beneficiary designation forms may end up transferring the deceased employee’s compensation and benefits to someone who is not legally entitled to them, which could expose the employer to risk. In the absence of a beneficiary designation, the deceased employee’s compensation and benefits will pass to the employee’s estate, necessitating legal proceedings through the court.
How are Compensation and Benefits Distributed If the Deceased Employee Has No Named Beneficiaries or Predeceased Named Beneficiaries?
Upon the death of an employee, the legal proceedings for distributing their final compensation and benefits (if there is no named beneficiary or a named beneficiary predeceases) differ significantly depending on whether they had a valid will. If the employee died testate (i.e., with a will), the process involves probate, where the will is validated by the court, and the named executor is granted Letters Testamentary to manage the estate, pay debts and taxes, and then distribute the remaining assets according to the will’s instructions, including any benefits from the employer. Conversely, if the employee died intestate (i.e., without a will), the court appoints an administrator who receives Letters of Administration and is responsible for inventorying assets, paying debts and taxes, and then distributing the remaining assets, including employer-held benefits, to the legal heirs as determined by the state’s intestacy laws. In both cases, court involvement is necessary to legally authorize the transfer of the deceased employee’s assets, although the presence of a will provides a predetermined roadmap for distribution, while intestacy requires the court to apply statutory rules of inheritance.
Can Final Wages Be Paid to the Deceased Employee’s Bank Account?
No. The deceased employee’s final wages should not be paid to their bank account, but should, instead, be paid to their beneficiary identified in the beneficiary designation form (if there is one) or to their estate in accordance with state laws. Final wages include an employee’s annual salary, accrued but unused paid time-off and accrued but unpaid bonuses or commissions. Special tax-withholding rules apply depending on when the final wages are paid, and employers should coordinate with their payroll providers to ensure that they comply with these rules.
How are a Deceased Employee’s Equity Awards Treated?
In general, equity incentive plans provide that, on a termination due to death, employees forfeit unvested equity awards—such as restricted stock, stock options and restricted stock units—but that employees retain their vested equity awards. In the case of stock options, on a termination due to death, the employee’s estate will often have up to 12 months following termination to exercise the vested options. This longer time period can come in handy because the probate process can often take months. Additionally, vested stock options can be exercised by the employee’s estate on death. In certain limited circumstances, the vesting of all or a portion of an employee’s equity award may accelerate on a termination due to death, so it is important that a company carefully check their equity plan documents and the deceased employee’s offer letter or employment agreement to ensure that they honor the deceased employee’s contractual entitlements.
How Are a Deceased Employee’s Retirement Plan Benefits Treated?
A company should carefully review their 401(k) plan documents to confirm (i) whether the deceased employee is fully vested in their 401(k) plan account balance and, if not, whether the plan provides for full vesting on death and (ii) whether the plan provides for an employer contribution and, if so, whether the eligibility requirements for the employer contributions are waived on death. (They often are.) The deceased employee’s spouse is the default beneficiary unless a signed waiver exists. Employers should work closely with their legal counsel and 401(k) plan provider or recordkeeper to ensure that the deceased employee’s 401(k) account balance is being distributed in accordance with the 401(k) plan terms and the beneficiary designation form (if there is one). In general, a beneficiary may keep the 401(k) account in the plan, roll over the account to another 401(k) plan or individual retirement account (IRA) or receive a distribution of the balance.
Are There Other Employee Benefits That May Be Triggered on Death?
Yes. A deceased employee’s dependents may be eligible for life insurance benefits and health care coverage under COBRA. When an employee dies, an employer should promptly notify their medical, dental, vision and life insurance providers and furnish them with a copy of the employee’s death certificate. The company should also provide the life insurance provider with a copy of any beneficiary designation forms. Additionally, the death of an employee is an event that entitles the deceased employee’s eligible dependents to health care coverage under COBRA for up to 36 months (as opposed to the regular 18 months) following death. Finally, a company should evaluate whether there are any other benefits—such as flexible spending accounts or health savings accounts—that will need to be addressed.
Are There Actions That Employers Can Take to Assist with Employee Estate Planning?
There are a number of ways employers can take meaningful actions to assist their employees with estate planning, including by offering educational workshops or seminars on the basics of estate planning. Providing employees with essential knowledge on foundational documents like a will can guide employees to direct the distribution of their assets and designate guardians for minor children, preventing potential complications and ensuring their wishes are honored. However, it is equally important to highlight that assets with beneficiary designations, such as life insurance policies and retirement accounts, will typically transfer directly to the named beneficiaries outside of probate. Ensuring these designations are accurately completed and kept up-to-date with life changes—like marriage, divorce, or the birth of a child—is paramount. By helping employees understand and manage both formal estate planning documents and beneficiary designations, employers can reduce potential administrative burdens and legal complications down the line.