The popularity of hedge funds, stock-option grants and other investments that can be tricky to value is giving warring spouses something new to fight over. At the same time, the IRS is keeping a sharp lookout for cases where two separate taxpayers both claim the kids as dependents, a big no-no.
The list of potential blunders facing splitting spouses is head-spinning: Dividing a stock portfolio the wrong way can trigger vastly unequal capital-gains-tax hits. Overlooking the mysterious QDRO form (pronounced "KWA-dro") can make a mess of dividing a 401(k).
All of this is proving to be a boon to the nascent industry of "certified divorce financial analysts." For fees of $150 to $250 or so an hour, these advisers help to navigate the economic aspects of divorce, as opposed to the legal issues like custody that are the domain of divorce lawyers.
In recent years, about 2,500 of these divorce specialists have been trained, according to the Institute for Divorce Financial Analysts, with new registrants increasing about 25% a year. Financial-services giants including Merrill Lynch & Co., Morgan Stanley and Ameriprise Financial Inc. have them on staff as well. Many are listed at www.institutedfa.com.
They offer to watch out for tax snafus, help clients obtain health insurance after a split, and demystify tough-to-value private-equity or hedge-fund investments. They also advise clients on which assets to fight for, and which to skip.
Some common blunders: Dividing a stock portfolio down the middle without checking for losses or gains -- which can trigger either a tax break or a big capital-gains tax hit.
Janet Drobinske, of Littleton, Colo., recently went through a divorce after 20 years of marriage. When it came to dividing up the assets, "it was easy enough to say, 'let's split this equally,' " says Ms. Drobinske, 45 years old. But after a divorce analyst they hired figured out how much the different assets, including a 401(k) plan, their house and other investments, might be worth years from now, the asset division that looked even at first, eventually seemed less so. "I couldn't have anticipated that," says Ms. Drobinske.
The declining housing market in many parts of the country is creating new headaches for divorcing couples. Sandra Stuerke of Longmont, Colo., had her house appraised nine months before her divorce was finalized. During that time, its value dropped by about $20,000. As a result Ms. Stuerke, 48 years old and a dog trainer, received less money from her ex-husband's other assets in the divorce settlement.
There are steps you can take to avoid house-related tax hits. If you keep the house and retitle it in your name, but end up selling it after the split, you may be able to shield only as much as $250,000 of the gains from capital-gains taxes. Consider selling the house while you're still married, or include specific provisions for the sale of the house in the divorce decree, to shield as much as $500,000 from capital-gains taxes.
The QDRO -- short for Qualified Domestic Relations Order -- is a court order that spells out who gets what in an employer-sponsored retirement plan such as a pension or a 401(k). QDROs must be approved by both the employer's retirement-plan administrator and the divorce-court judge.
The document lets you make transfers to an Individual Retirement Account, or make early fund withdrawals from the plan without paying the usual 10% IRS penalty if you're under age 59½. (You'll still have to pay income taxes on withdrawals.)
Try to complete the QDRO before the divorce is finalized. Otherwise, if your ex should die, remarry or leave the company, it may be tough to receive any retirement money.
Adding to the confusion, IRAs don't require QDROs. If you write it in your divorce agreement, you can split an IRA by transferring the funds directly into other IRAs without being subject to penalties or taxes.
If you're paying alimony, you can claim the payments as a deduction. But if you receive alimony payments, they count as taxable income. Child-support payments are neither deductible nor taxable.
"People screw up the deductibility and taxation of alimony and that can make a tremendous difference to a settlement," says Gaetano Ferro, president of the American Academy of Matrimonial Lawyers.
Other tips: Take out a term life-insurance policy on the alimony-paying spouse. And update wills, trusts and beneficiary designations on retirement plans and insurance policies, so that your ex doesn't end up inheriting an unintended windfall.
"With all the clients I've followed up on, when I ask 'Have you done your new wills?' the answer probably 95% of the time is 'uh, no,' " says Natalie Nelson, a Denver divorce financial analyst.
What you should know about QDROs
December 16, 2007
A Qualified Domestic Relations Order (QDRO) is a legal document that directs the administrator of a pension plan to give a certain amount of an employee's pension to his/her non-employee ex-spouse after the divorce is final. Here are the top four mistakes people make when it comes to QDROs.
Consider this scenario: husband and wife happily sign the divorce decree, relieved that the divorce proceedings are finally over. The settlement agreement states, "All retirement assets will be equally divided between the parties."
Fast-forward three months. The parties jointly retain a Qualified Domestic Relations Order (QDRO) expert to draft the documents dividing up the retirement plans. Uh oh. His pension is a non-qualified plan and can't be divided. Her 401(k) has dropped in value by $50,000 -- what was the official division date? The divorce decree doesn't say. Are supplements, temporary benefits, and cost-of-living adjustments on both parties' pensions to be included or excluded? The divorce decree doesn't say.
Sadly, this is an all-too-common situation. It's common because there is much confusion in the legal community regarding pension and retirement plans in general and, more specifically, QDROs. QDROs have only been in existence since 1984. Exposure to increased liability has increased steadily amongst family-law practitioners as attorneys struggle with untangling the pension maze. This article attempts to shed some light on the most common mistakes and ways to avoid them.
Common Mistake #1
Not obtaining all necessary information on retirement plans
No two pension/retirement plans are identical. Ford's Pension Plan for Salaried Employees is radically different from Dow Chemical's Plan for Hourly Employees. GM's Stock Savings Plan is drastically different from Dr. Jones' Profit Sharing Plan. For example, some plans have early retirement buy-outs, supplements, or temporary benefits that may drop off at age 62 or 65 (when the retiree becomes eligible for Social Security benefits). Then there are some non-qualified plans that may not be divisible at all. It's crucial to have all of this information available during the negotiation process. After both parties sign on the dotted line, it's too late to start discussing whether or not supplements were intended by the parties to be included in the division. This could be a difference between receiving 50% of $4,000 per month or 50% of $2,000 per month for the alternate payee. It could also be the difference for the employee between losing 50% of $4,000 per month or 50% of $2,000 per month.
The way to avoid these types of mistakes is adequate Discovery with the plan administrator early in the case. Another solution is to involve a pension expert before it's time to draft the QDRO. An experienced QDRO drafter knows the difference between Ford's Hourly and Salaried Plan. Further, if they don't know the answers, they certainly know the questions to ask and of whom. Take advantage of their expertise and involve them in the case during the negotiation process.
Common Mistake #2
Both parties jointly retain the QDRO drafter
This is one of the most common mistakes. A QDRO is not a neutral document. It is an advocating document -- in other words, it is drafted to benefit one side -- at the expense of the other. Consider the case of Bill and Hilary. Their divorce decree states that Hilary is to receive $1,000 per month of Bill's pension. Bill is to receive the remaining benefits. Seems fairly straightforward, right?
But wait. Bill says, "Hilary is never going to receive a dime of my pension. I just won't retire!" Hilary's attorney hires the QDRO drafter, who drafts the QDRO to allow Hilary to access her $1,000 at Bill's earliest retirement age -- whether he retires or not. This is called using a Separate Interest division method. On the other hand, if Bill's attorney had hired the QDRO drafter, he would have used the other approach, which is called the Shared Benefit approach. In addition to making Hilary wait until Bill retires to receive her $1,000 per month, this method also requires that, if Hilary were to die after she begins receiving benefits, her $1,000 automatically reverts to Bill.
Volunteer to get the QDRO drafted, and ask the expert to make sure that the document advocates for your interest. Remember, there is no such thing as a neutral QDRO.
Common Mistake #3
Waiting too long to draft the QDRO
Frank and Sheryl were married for 25 years. Their divorce decree states that Sheryl is to receive 50% of Frank's pension. She is dependent upon that income to maintain her lifestyle for the next 25 years. Frank dies before the QDRO is drafted and approved. Does it matter what the divorce decree says? Technically, no. The only document that can divide up the pension plan, from the plan administrator's view, is the QDRO. Maybe Sheryl can re-open the case and have the QDRO entered nunc pro tunc. But that will likely cost her time and money in legal fees that she can't afford.
The best solution is to have the QDRO entered simultaneously with the judgment. This is not always a practical solution: sometimes it takes months for a draft QDRO to be approved by a plan administrator. Certain companies, such as GM, won't even review a draft QDRO. At the very least, the QDRO must be drafted shortly after the judgment is entered to avoid exposure to liability.
Common Mistake #4
Using the employer-provided sample QDRO
To simplify things, Kerri's attorney decides to use the sample QDRO provided by Jim's employer, Fly Automotive. Fly's sample QDRO is two pages long and doesn't address pre-retirement and post-retirement survivor benefits if Kerri were to pre-decease Jim. It also doesn't include standard language to protect Kerri, nor does it address employer-provided early-retirement supplements.
Remember, a QDRO is not a neutral document. It should benefit either the employee or the non-employee spouse. Fly Automotive's Sample QDRO benefits neither party: it benefits Fly Automotive. It is intended to streamline the approval process and make Fly's job easier when deciding whether to approve or reject a QDRO. Employer-provided sample QDROs usually don't address or explain all the possible options available to either party.
Use the sample QDRO as a guide, not a template. It gives a good indication of what the plan administrator would like to see in the QDRO. For example, some plans require you to use the word "supplement" instead of "subsidy". If you use the wrong word, your QDRO will be rejected. This is the type of information that the sample is best used for.
The Last Word
The most important mistake to avoid is thinking that if the pension issue is ignored, it will go away. A highly competent and well-respected attorney once said, "I don't want to deal with QDRO issues -- it's too much liability. I tell my clients that they need to hire the QDRO expert on their own after the divorce is over." This is a dangerous attitude for attorneys to take. Yes, this area is technical and complicated, but ignoring these issues doesn't make them disappear -- it just makes them worse. Involve an expert early on in the case. Ask many questions and have them lend their knowledge and expertise in time to help. These issues need to be addressed during the negotiation process in order to protect you from losing pension money down the road.
Drafting Qualified Domestic Relations Orders
What is the best way to divide a participant's pension benefits in a QDRO?
There is no single best way to divide pension benefits in a QDRO. What will be best in a specific case will depend on many factors, including the type of pension plan, the nature of the participant's pension benefits, and why the parties are seeking to divide those benefits.
In deciding how to divide a participant's pension benefits in a QDRO, it is also important to consider two aspects of a participant's pension benefits: the benefit payable under the plan directly to the participant for retirement purposes (referred to here as the retirement benefit), and any benefit that is payable under the plan on behalf of the participant to someone else after the participant dies (referred to here as the survivor benefit). These two aspects of a participant's pension benefits are discussed separately in this booklet only in order to emphasize the importance of considering how best to divide pension benefits.
How much can be given to an alternate payee through a QDRO?
A QDRO can give an alternate payee any part or all of the pension benefits payable with respect to a participant under a pension plan. However, the QDRO cannot require the plan to provide increased benefits (determined on the basis of actuarial value); nor can a QDRO require a plan to provide a type or form of benefit, or any option, not otherwise provided under the plan. The QDRO also cannot require the payment of benefits to an alternate payee that are required to be paid to another alternate payee under another QDRO already recognized by the plan.
Reference: ERISA §§ 206(d)(3)(B)(i)(I), 206(d)(3)(D), 206(d)(3)(E); IRC §§ 414(p)(1)(A)(i), 414(p)(3), 414(p)(4)
Why are the reasons for dividing the pension benefits important?
Generally, QDROs are used either to provide support payments (temporary or permanent) to the alternate payee (who may be the spouse, former spouse or a child or other dependent of the participant) or to divide marital property in the course of dissolving a marriage. These differing goals often result in different choices in drafting a QDRO. This answer describes two common different approaches in drafting QDROs for these two different purposes.
One approach that is used in some orders is to split the actual benefit payments made with respect to a participant under the plan to give the alternate payee part of each payment. This approach to dividing retirement benefits is often called the shared payment approach. Under this approach, the alternate payee will not receive any payments unless the participant receives a payment or is already in pay status. This approach is often used when a support order is being drafted after a participant has already begun to receive a stream of payments from the plan (such as a life annuity).
An order providing for shared payments, like any other QDRO, must specify the amount or percentage of the participant's benefit payments that is assigned to the alternate payee (or the manner in which such amount or percentage is to be determined). It must also specify the number of payments or period to which it applies. This is particularly important in the shared payment QDRO, which must specify when the alternate payee's right to share the payments begins and ends. For example, when a state authority seeks to provide support to a child of a participant, an order might require payments to the alternate payee to begin as soon as possible after the order is determined to be a QDRO and to continue until the alternate payee reaches maturity. Alternatively, when support is being provided to a former spouse, the order might state that payments to the alternate payee will end when the former spouse remarries. If payments are to end upon the occurrence of an event, notice and reasonable substantiation that the event has occurred must be provided for the plan to be able to comply with the terms of the QDRO.
Orders that seek to divide a pension as part of the marital property upon divorce or legal separation often take a different approach to dividing the retirement benefit. These orders usually divide the participant's retirement benefit (rather than just the payments) into two separate portions with the intent of giving the alternate payee a separate right to receive a portion of the retirement benefit to be paid at a time and in a form different from that chosen by the participant. This approach to dividing a retirement benefit is often called the separate interest approach.
An order that provides for a separate interest for the alternate payee must specify the amount or percentage of the participant's retirement benefit to be assigned to the alternate payee (or the manner in which such amount or percentage is to be determined). The order must also specify the number of payments or period to which it applies, and such orders often satisfy this requirement simply by giving the alternate payee the right that the participant would have had under the plan to elect the form of benefit payment and the time at which the separate interest will be paid. Such an order would satisfy the requirements to be a QDRO.
Federal law does not require the use of either approach for any specific domestic relations purpose, and it is up to the drafters of any order to determine how best to achieve the purposes for which pension benefits are being divided. Further, the shared payment approach and the separate interest approach can each be used for either defined benefit or defined contribution plans. However, it is important in drafting any order to understand and follow the terms of the plan. An order that would require a plan to provide increased benefits (determined on an actuarial basis) or to provide a type or form of benefit, or an option, not otherwise available under the plan cannot be a QDRO.
In addition to determining whether or how to divide the retirement benefit, it is important to consider whether or not to give the alternate payee a right to survivor benefits or any other benefits payable under the plan.
Reference: ERISA § 206(d)(3)(C)(ii) - (iv); IRC § 414(p)(2)(B) - (D)
In deciding how to divide the participant's pension benefits, why is understanding the type of pension plan important?
Understanding the type of pension plan is important because the order cannot be a QDRO unless its assignment of rights or division of pension benefits complies with the terms of the plan. Parties drafting a QDRO should read the plan's summary plan description and other plan documents to understand what pension benefits are provided under the plan.
Pension plans may be divided generally into two types: Defined Benefit Plans and Defined Contribution Plans.
A defined benefit plan promises to pay each participant a specific benefit at retirement. This basic retirement benefit is usually based on a formula that takes into account factors like the number of years a participant works for the employer and the participant's salary. The basic retirement benefit is generally provided in the form of periodic payments for the participant's life beginning at what the plan calls normal retirement age. This stream of periodic payments is generally known as an annuity. A participant's basic retirement benefit under a defined benefit plan may increase over time, either before or after the participant begins receiving benefits, due to a variety of circumstances, such as increases in salary or the crediting of additional years of service with the employer (which are taken into account under the plan's benefit formula), or through amendment to the plan's provisions, including some amendments to provide cost of living adjustments.
Defined benefit plans may promise to pay benefits at various times, under certain circumstances, or in alternative forms. Benefits paid at those times or in those forms may have a greater actuarial value than the basic retirement benefit payable by the plan at the participant's normal retirement age. When one form of benefit has a greater actuarial value than another form, the difference in value is often called a subsidy.
A defined contribution plan, by contrast, is a type of pension plan that provides for an individual account for each participant. The participant's benefits are based solely on the amount contributed to the participant's account and any income, expenses, gains or losses, and any forfeitures of accounts of other participants that may be allocated to such participant's account. Examples of defined contribution plans include profit-sharing plans (like 401(k) plans), employee stock ownership plans (ESOPs), and money purchase plans. A participant's basic retirement benefit in a defined contribution plan is the amount in his or her account at any given time. This is generally known as the participant's account balance. Defined contribution plans commonly provide for retirement benefits to be paid in the form of a lump sum payment of the participant's entire account balance. Defined contribution plans by their nature do not offer subsidies.
It should be noted, however, that some defined benefit plans provide for lump sum payments, and some defined contribution plans provide for annuities.
Reference: IRS Notice 97-11, 1997-2 IRB 49 (Jan. 13, 1997)
What are survivor benefits, and why should a QDRO take them into account?
Federal law requires all pension plans, whether they are defined benefit plans or defined contribution plans, to provide benefits in a way that includes a survivor benefit for the participant's spouse. The provisions creating these protections are contained in section 205 of ERISA and sections 401(a)(11) and 417 of the Code. The type of survivor benefit that is required by Federal law depends on the type of pension plan. Plans also may provide for survivor (or death) benefits that are in addition to those required by Federal law. Participants and alternate payees drafting a QDRO should read the plan's summary plan description and other plan documents to understand the survivor benefits available under the plan.
Federal law generally requires that defined benefit plans and certain defined contribution plans pay retirement benefits to participants who were married on the participant's annuity starting date (this is the first day of the first period for which an amount is payable to the participant) in a special form called a qualified joint and survivor annuity (QJSA) unless the participant elects a different form and the spouse consents to that election. When benefits are paid as a QJSA, the participant receives a periodic payment (usually monthly) during his or her life, and the surviving spouse of the participant receives a periodic payment for the rest of the surviving spouse's life upon the participant's death. Federal law also generally requires that, if a married participant with a non-forfeitable benefit under one of these types of plans dies before his or her annuity starting date, the plan must pay the surviving spouse of the participant a monthly survivor benefit. This benefit is called a qualified pre-retirement survivor annuity (QPSA).
Those defined contribution plans that are not required to pay pension benefits to married participants in the form of a QJSA or QPSA (like most 401(k) plans) are required by Federal law to pay any balance remaining in the participant's account after the participant dies to the participant's surviving spouse. If the spouse gives written consent, the participant can direct that upon the participant's death any balance remaining in the account will be paid to a beneficiary other than the spouse, for example, the couple's children. Under these defined contribution plans, Federal law does not require a spouse's consent to a participant's decision to withdraw any portion (or all) of his or her account balance during the participant's life.
If a participant and his or her spouse become divorced before the participant's annuity starting date, the divorced spouse loses all right to the survivor benefit protections that Federal law requires be provided to a participant's spouse. If the divorced participant remarries, the participant's new spouse may acquire a right to the Federally mandated survivor benefits. A QDRO, however, may change that result. To the extent that a QDRO requires that a former spouse be treated as the participant's surviving spouse for all or any part of the survivor benefits payable after the death of the participant, any subsequent spouse of the participant cannot be treated as the participant's surviving spouse. For example, if a QDRO awards all of the survivor benefit rights to a former spouse, and the participant remarries, the participant's new spouse will not receive any survivor benefit upon the participant's death. If such a QDRO requires that a defined benefit plan, or a defined contribution plan subject to the QJSA and QPSA requirements, treat a former spouse of a participant as the participant's surviving spouse, the plan must pay the participant's benefit in the form of a QJSA or QPSA unless the former spouse who was named as surviving spouse in the QDRO consents to the participant's election of a different form of payment.
It should also be noted that some pension plans provide that a spouse of a participant will not be treated as married unless he or she has been married to the participant for at least a year. If the pension plan to which the QDRO relates contains such a one-year marriage requirement, then the QDRO cannot treat the alternate payee as a surviving spouse if the marriage lasted for less than one year.
In addition, it is important to note that some pension plans may provide for survivor benefits in addition to those required by Federal law for the benefit of the surviving spouse. Generally, however, the only way to establish a former spouse's right to survivor benefits such as a QJSA or QPSA is through a QDRO. A QDRO may provide that a part or all of such other survivor benefits shall be paid to an alternate payee rather than to the person who would otherwise be entitled to receive such death benefits under the plan. As discussed above, a spouse or former spouse can also receive a right to receive (as a separate interest or as shared payments) part of the participant's retirement benefit as well as a survivor's benefit.
Reference: ERISA §§ 205, 206(d)(3)(F); IRC §§ 401(a)(11), 414(p)(5), 417
How may the participant's retirement benefit be divided if the pension plan is a defined contribution plan?
An order dividing a retirement benefit under a defined contribution plan may adopt either a separate interest approach or a shared payment approach (or some combination of these approaches). Orders that provide the alternate payee with a separate interest, either by assigning to the alternate payee a percentage or a dollar amount of the account balance as of a certain date, often also provide that the separate interest will be held in a separate account under the plan with respect to which the alternate payee is entitled to exercise the rights of a participant. Provided that the order does not assign a right or option to an alternate payee that is not otherwise available under the plan, an order that creates a separate account for the alternate payee may qualify as a QDRO.
Orders that provide for shared payments from a defined contribution plan should clearly establish the amount or percentage of the participant's payments that will be allocated to the alternate payee and the number of payments or period of time during which the allocation to the alternate payee is to be made. A QDRO can specify that any or all payments made to the participant are to be shared between the participant and the alternate payee.
In drafting orders dividing benefits under defined contribution plans, parties should also consider addressing the possibility of contingencies occurring that may affect the account balance (and therefore the alternate payee's share) during the determination period. For example, parties might be well advised to specify the source of the alternate payee's share of a participant's account that is invested in multiple investments because there may be different methods of determining how to derive the alternate payee's share that would affect the value of that share. The parties should also consider how to allocate any income or losses attributable to the participant's account that may accrue during the determination period. If an order allocates a specific dollar amount rather than a percentage to an alternate payee as a shared payment, the order should address the possibility that the participant's account balance or individual payments might be less than the specified dollar amount when actually paid out.
Reference: ERISA §§ 206(d)(3)(C); IRC § 414(p)(2)
How may the participant's retirement benefit be divided if the pension plan is a defined benefit plan?
As indicated earlier, an order may adopt either the shared payment or the separate interest approach (or a combination of the two) in dividing pension benefits in a defined benefit plan.
If shared payments are desired, the order should specify the amount of each shared payment allocated to the alternate payee either by percentage or by dollar amount. If the order describes the alternate payee's share as a dollar amount, care should be taken to establish that the payments to the participant will be sufficient to satisfy the allocation, and the order should indicate what is to happen in the event a payment is insufficient to satisfy the allocation. The order must also describe the number of payments or period of time during which the allocation to the alternate payee is to be made. This is usually done by specifying a beginning date and an ending date (or an event that will cause the allocation to begin and/or end). If an order specifies a triggering event that may occur outside the plan's knowledge, notice of its occurrence must be given to the plan before the plan is required to act in accordance with the order. If the intent is that all payments made under the plan are to be shared between the participant and the alternate payee, the order may so specify.
A defined benefit plan may provide for subsidies under certain circumstances and may also provide increased benefits or additional benefits either earned through additional service or provided by way of plan amendment. A QDRO that uses the shared payment method to give the alternate payee a percentage of each payment may be structured to take into account any such future increases in the benefits paid to the participant. Such a QDRO does not need to address the treatment of future subsidies or other benefit increases, because the alternate payee will automatically receive a share of any subsidy or other benefit increases that are paid to the participant. If the parties do not wish to provide for the sharing of such subsidies or increases, the order should so specify.
If a separate interest is desired for the alternate payee, it is important that the order be based on adequate information from the plan administrator and the plan documents concerning the participant's retirement benefit and the rights, options, and features provided under the plan. In particular, the drafters of a QDRO should consider any subsidies or future benefit increases that might be available with respect to the participant's retirement benefit. The order may specify whether, and to what extent, an alternate payee is to receive such subsidies or future benefit increases.
Reference: ERISA §§ 206(d)(3)(C), 206(d)(3)(D); IRC §§ 414(p)(2), 414(p)(3)
May the QDRO specify the form in which the alternate payee's benefits will be paid?
A QDRO that provides for a separate interest may specify the form in which the alternate payee's benefits will be paid subject to the following limitations:
* The order may not provide the alternate payee with a type or form of payment, or any option, not otherwise provided under the plan
* The order may not provide any subsequent spouse of an alternate payee with the survivor benefit rights that Federal law requires be provided to spouses of participants under section 205 of ERISA
* For any tax-qualified pension plan, the payment of the alternate payee's benefits must satisfy the requirements of section 401(a)(9) of the Code respecting the timing and duration of payment of benefits. In determining the form of payment for an alternate payee, an order may substitute the alternate payee's life for the life of the participant to the extent that the form of payment is based on the duration of an individual's life. The timing and forms of benefit available to an alternate payee under a tax-qualified plan may be limited by section 401(a)(9) of the Code
Alternatively, a QDRO may (subject to the limitations described above) give the alternate payee the right that the participant would have had under the plan to elect the form of benefit payment. For example, if a participant would have the right to elect a life annuity, the alternate payee may exercise that right and choose to have the assigned benefit paid over the alternate payee's life. However, the QDRO must permit the plan to determine the amount payable to the alternate payee under any form of payment in a manner that does not require the plan to pay increased benefits (determined on an actuarial basis).
A plan may by its own terms provide alternate payees with additional types or forms of benefit, or options, not otherwise provided to participants, such as a lump-sum payment option, but the plan cannot prevent a QDRO from assigning to an alternate payee any type or form of benefit, or option, provided generally under the plan to the participant.
Reference: ERISA §§ 206(d)(3)(A), 206(d)(3)(D), 206(d)(3)(E)(i)(III); IRC §§ 401(a)(9), 401(a)(13)(B), 414(p)(3), 414(p)(4)(A)(iii)
When can the alternate payee get the benefits assigned under a QDRO?
A QDRO that provides for shared payments must specify the date on which the alternate payee will begin to share the participant's payments. Such a date, however, cannot be earlier than the date on which the plan receives the order. With respect to a separate interest, an order may either specify the time (after the order is received by the plan) at which the alternate payee will receive the separate interest or assign to the alternate payee the same right the participant would have had under the plan with regard to the timing of payment. In either case, a QDRO cannot provide that an alternate payee will receive a benefit earlier than the date on which the participant reaches his or her earliest retirement age, unless the plan permits payments at an earlier date.
The plan itself may contain provisions permitting alternate payees to receive separate interests awarded under a QDRO at an earlier time or under different circumstances than the participant could receive the benefit. For example, a plan may provide that alternate payees may elect to receive a lump sum payment of a separate interest at any time.
Reference: ERISA §§ 206(d)(3)(C), 206(d)(3)(D), 206(d)(3)(E); IRC §§ 401(a)(9), 414(p)(2), 414(p)(3), 414(p)(4)
What is earliest retirement age, and why is it important?
For QDROs, Federal law provides a very specific definition of earliest retirement age, which is the earliest date as of which a QDRO can order payment to an alternate payee (unless the plan permits payments at an earlier date). The earliest retirement age applicable to a QDRO depends on the terms of the pension plan and the participant's age. Earliest retirement age is the earlier of two dates:
* The date on which the participant is entitled to receive a distribution under the plan, or
* The later of either:
* The date the participant reaches age 50, or
* The earliest date on which the participant could begin receiving benefits under the plan if the participant separated from service with the employer
Drafters of QDROs should consult the plan administrator and the plan documents for information on the plan's earliest retirement age. The following examples illustrate the concept of earliest retirement age.
Example 1 - The pension plan is a defined contribution plan that permits a participant to make withdrawals only when he or she reaches age 59½ or terminates from service. The earliest retirement age for a QDRO under this plan is the earlier of:
* When the participant actually terminates employment or reaches age 59½
* The later of the date the participant reaches age 50 or the date the participant could receive the account balance if the participant terminated employment
Since the participant could terminate employment at any time and thereby be able to receive the account balance under the plan's terms, the later of the two dates described in above is age 50. The earliest retirement age formula for this plan can be simplified to read the earlier of:
* Actually reaching age 59½ or terminating employment or
* Age 50. Since age 50 is earlier than age 59½, the earliest retirement age for this plan will be the earlier of age 50 or the date the participant actually terminates from service
Example 2 - The pension plan is a defined benefit plan that permits retirement benefits to be paid beginning when the participant reaches age 65 and terminates employment. It does not permit earlier payments. The earliest retirement age for this plan is the earlier of:
* The date on which the participant actually reaches age 65 and terminates employment, or
* The later of age 50 or the date on which the participant reaches age 65 (whether he or she terminates employment or not)
Because age 65 is later than age 50, the second part of the formula can be simplified to read age 65 so that the formula reads as follows, the earliest retirement age is the earlier of:
* The date on which the participant reaches age 65 and actually terminates or
* The date the participant reaches age 65
Under this plan, therefore, the earliest retirement age will be the date on which the participant reaches age 65.
Reference: ERISA § 206(d)(3)(E); IRC § 414(p)(4)
Dividing Pensions: Separate Interest vs. Shared Interest
When dividing a Defined Benefit Plan (Pension) in a divorce case, the QDRO can be drafted using either a “Shared Interest” approach or a “Separate Interest” approach. The main difference between the two is that Separate Interest is based on the Alternate Payee’s lifetime and Shared Interest is based on the Participant’s lifetime. Below are some pros and cons of each approach:
• Adjusts the amount of the award to be paid over the lifetime of the Alternate Payee rather than the Participant’s lifetime.
• “Post-retirement” survivorship language for the benefit of the Alternate Payee is not required, because he or she is automatically guaranteed a lifetime of actuarially-adjusted benefits.
• It is still necessary to include “pre-retirement” survivorship language to secure the Alternate Payee’s right to benefits in the event of the Participant’s death before retirement.
• The Alternate Payee can choose to begin receiving benefits at a different time than the Participant.
• If the Alternate Payee is much younger than the Participant, this approach is not favorable.
• If the Alternate Payee predeceases the Participant, the benefit may revert back to the Participant or just disappear.
• Benefits are adjusted over the lifetime of the Participant.
• Must have pre- and post-retirement survivor language in the QDRO to secure the benefit for the Alternate Payee in the event that the Participant dies first.
• Only method allowed if the Participant has already retired.
• In the event that the Alternate Payee predeceases the Participant, the benefit reverts back to the Participant (if allowed by the plan).
• Participant must begin receiving benefits before the Alternate Payee may receive benefits.
• If the Alternate Payee is younger, he or she will receive more benefits using this method since the benefit is actuarially based on the Participant’s life expectancy.
Property settlements should spell out the terms of the division of the pension. It is not uncommon to see agreements containing clauses such as “the pension will be divided between the parties.” Unless survivorship issues are agreed upon and put into the agreement, it is likely that one may be forced to use the Separate Interest approach, which may not be consistent with best interests.
Glossary of QDRO Terms
The following terms may be useful in understanding division of retirement benefits through Qualified Domestic Relations Orders (QDRO's).These terms may help you to choose an online QDRO preparer and help you understand the terminology that you will need to search for an online QDRO preparation service.
Actuarially Equivalent — Different benefits or benefit forms having the same value as of a given date using a specified set of assumptions.
Alternate Payee — A participant’s spouse, former spouse, child, or other dependent who, under a QDRO, has a right to receive all, or a portion, of the participant’s pension benefits under a plan.
Annuity — A form of benefit in which payments are made at regular intervals for a specified period of time. The most common form of annuity pays monthly benefits for life.
Beneficiary — The person named to receive benefits upon the death of a participant or alternate payee.
Benefit — A payment provided for under a pension plan.
Certain-and-Continuous (C&C) Annuity — An annuity that pays benefits over the longer of the recipient’s life or a specified period.
Contingent Alternate Payee — An alternate payee under a QDRO whose benefit is contingent upon the death of an alternate payee.
Defined Benefit Plan — A type of pension plan that promises participants specified benefits at retirement. Retirement benefits usually are based on the number of years worked for a company or in an industry and may also be based on salary during that time.
Defined Contribution Plan — A type of pension plan in which an employee receives the amount in an individual account, which includes contributions made by the employer and, if applicable, the employee. Retirement benefits are based on the amount in each participant’s account, adjusted for investment experience and plan expenses. The most common types of defined contribution plans include profit-sharing plans, 401(k) plans, employee stock ownership plans (ESOPs), thrift savings plans, and money purchase plans.
Domestic Relations Order — Any judgment, decree, or order (including approval of a property settlement agreement) that (1) provides child support, alimony payments, or marital property rights to a spouse, former spouse, child, or other dependent of a participant, and (2) is made pursuant to a state’s domestic relations law.
Earliest PBGC Retirement Date (EPRD) — The “earliest PBGC retirement date” has a specific meaning for PBGC purposes and is defined in PBGC regulation 29 C.F.R. §4022.10. Typically, a participant’s age as of his or her EPRD will be 55 unless (1) under the plan’s terms, the participant cannot receive a benefit until a later age, or (2) PBGC determines under a facts-and-circumstances test that the participant could retire earlier than 55. PBGC tells each participant what his or her EPRD is in a benefit determination.
Guaranteed Benefits — The amount of a pension plan’s benefit that is guaranteed by PBGC as of the plan’s termination date.
Joint-and-Survivor Annuity — An annuity that pays benefits over the participant’s lifetime and thereafter over the lifetime of the person named as the survivor.
Life Expectancy — The number of years a person is expected to live, on average, after a given age.
Lump Sum — A form of benefit payment in which the entire benefit is paid at one time.
Normal Retirement Age — The age for normal retirement defined under a plan. In most cases, the normal retirement age will not be greater than 65 years of age or, if later, the fifth anniversary of the date the participant commenced participation under the plan.
Participant — An employee or former employee who may be entitled to a benefit under a pension plan, or whose beneficiaries may be entitled to a benefit. A participant is said to participate in or to be covered by the plan.
PBGC Model Child Support Shared Payment QDRO — The PBGC Model Child Support Shared Payment QDRO gives the alternate payee a portion of the participant’s benefit payments under the plan during the participant’s lifetime. This model is designed to provide child support only; it is a simpler version of the PBGC Model Shared Payment QDRO.
PBGC Model Separate Interest QDRO — The PBGC Model Separate Interest QDRO divides the value of the participant’s benefits into two separate parts—one for the participant and one for the alternate payee. This model also allows for the assignment of survivor benefits.
PBGC Model Shared Payment QDRO — The PBGC Model Shared Payment QDRO gives the alternate payee a portion of the participant’s benefit payments under the plan during the participant’s lifetime. In other words, the participant and the alternate payee share the payments. This model also allows for the assignment of survivor benefits.
PBGC Model Treat-as-Spouse QDRO — The PBGC Model Treat-as-Spouse QDRO treats the alternate payee as the participant’s spouse for purposes of a qualified preretirement survivor annuity (QPSA), a qualified joint-and-survivor annuity (QJSA), or both. This model does not provide any part of the participant’s benefit to the alternate payee as a shared payment or separate interest.
Plan Administrator — The person or persons who administer the plan. If no one is designated as the administrator in the plan document, the employer is considered to be the plan administrator.
Qualified Domestic Relations Order (QDRO) — A QDRO is a domestic relations order that gives an alternate payee the right to receive all or a portion of the benefits payable to a participant under the plan, and that PBGC determines meets certain legal requirements with respect to information that must be provided, and provisions that cannot be included, in such an order.
Qualified Joint-and-Survivor Annuity (QJSA) — A QJSA is a joint-and-survivor annuity where (1) the participant receives a definite amount of money at regular intervals for life, and (2) after the participant dies, the surviving spouse (who may be the spouse to whom the participant was married at retirement, or a former spouse who is treated by a QDRO as the participant’s spouse) receives a definite amount of money (not less than 50% or more than 100% of the amount received by the participant before death) at regular intervals for life.
Qualified Preretirement Survivor Annuity (QPSA) — A QPSA is an annuity provided to a surviving spouse when a vested participant dies before receiving payment of his or her benefit. The annuity is paid for the life of the surviving spouse (who may be the spouse to whom the participant was married at the time the participant died, or a former spouse who is treated by a QDRO as the participant’s spouse), is calculated based on the benefit that had been earned by the participant before death, and generally is equal to the survivor’s portion of the QJSA. In PBGC-trusteed plans, the surviving spouse may elect to receive the QPSA in the form of a straight life annuity or certain-and-continuous annuity.
Single Life Annuity — An annuity that pays benefits over a period of time that depends, at least in part, on the survival of only one person, for example, a straight life annuity or certain-and-continuous annuity.
Spousal Consent — A spouse’s written and notarized agreement to allow the participant to waive the QPSA or elect a form of benefit other than a QJSA.
Spouse — Husband or wife as determined under applicable law. A QDRO can provide that the participant’s former spouse be treated as the participant’s spouse for certain pension benefits.
Straight Life Annuity — An annuity that pays benefits over the recipient’s lifetime. Once the recipient dies, no further annuity payments are payable to anyone.
Subsidized Early Retirement Benefit — Many plans allow “early retirement,” that is, a participant may retire before the participant reaches the normal retirement age defined under a plan. Some plans actuarially reduce the early retirement benefit to reflect the longer payout. Other plans may not reduce the benefit at all—for example, paying the same amount per month starting at age 60 as the participant would receive starting at age 65. To the extent that the benefit is not reduced actuarially, or only partially reduced, the benefit is a subsidized early retirement benefit.
Survivor Benefit — The survivor part of a preretirement survivor annuity or a joint-and-survivor annuity that is paid to a beneficiary after the participant dies.
Value — The actuarially determined amount needed at a point in time to provide a specific monthly benefit at some time in the future. Value depends on the amount of the monthly benefit payment, when the benefit payments start and stop, the age(s) of the recipient(s), mortality assumptions, and interest assumptions. Also referred to as “present value” or “actuarial present value.”