The benefits accumulated
under qualified pension and profit sharing plans are often one of the
largest assets a married couple owns. If the couple divorces, sometimes
their retirement benefits must be divided. Since 1984, federal pension law
has provided special procedures enabling family courts to divide pensions
in a divorce or separation.
Although the rules governing the division of retirement plan benefits
in a divorce are straightforward, strict compliance with applicable legal
requirements is necessary to avoid possible plan disqualification or the
taxation of benefits to the participant rather than the one receiving the
benefits.
Qualified Domestic Relations Orders
Pension law authorizes qualified retirement plans to comply with state
court domestic relations orders dividing pension benefits, whether by
separate court order or a court-approved property settlement agreement.
However, the order must satisfy certain requirements in order to be
considered a "qualified" domestic relations order (QDRO).
Generally, a domestic relations order is used to provide child support
or alimony payments, or to divide marital property as part of a divorce.
The QDRO creates or recognizes a right of an alternate payee to receive
all or a portion of the benefits payable to a plan participant. The
alternate payee is usually the spouse or former spouse but can also be a
child or other dependent of the participant.
Plans are required to have written reasonable procedures for
determining whether domestic relations orders are QDROs and for
administering distributions. The procedures should be designed to ensure
that QDRO determinations are made in a timely, efficient and
cost-effective manner, consistent with the administrator's fiduciary
duties under ERISA.
Valid QDRO Determination
The plan administrator is responsible for determining whether an order
is a QDRO. However, it is not the plan administrator's task to evaluate
the fairness of the QDRO but only to determine that the order meets the
legal requirements to be a valid QDRO.
To be a valid QDRO, the order must be sent to the plan administrator
and clearly specify the following required information:
- The name and last known mailing address of both the participant and
each alternate payee covered by the order;
- The amount or percentage of the participant's benefits to be paid to
the alternate payee (or the manner in which the amount or percentage is
to be determined);
- The number of payments or period to which the order applies; and
- The name of each plan to which the order relates.
A domestic relations order is not a QDRO if:
- It requires the plan to provide an alternate payee with any type or
form of benefit not otherwise provided by the plan;
- It requires the plan to provide for increased benefits; or
- It requires the plan to pay benefits that are already required to be
paid to another alternate payee under a prior QDRO.
Plan Administrator QDRO Duties
In most cases, the employer is the plan administrator. The employer may
be the plan administrator as a corporate entity, if it is a corporation,
or as a partnership, if that is its business structure. Or, the plan
administrator may be a named individual or a committee appointed by the
employer.
The plan administrator is required to promptly notify both the
participant and alternate payee of receipt of the order and to provide to
them a copy of the plan's written procedures for determining whether the
order is a QDRO.
During the review process, the plan administrator must separately
account for the amounts that would be payable to an alternate payee, and
be careful that benefits are not wrongly paid out to the participant,
i.e., participant loans, hardship withdrawals, or withdrawal of employee
contributions.
It is the plan administrator's responsibility to declare that a
domestic relations order is a QDRO within a reasonable period of time
after receipt of the order. The plan administrator must notify the
participant and alternate payee as to whether the order is a QDRO. If it
is determined that the order is not a QDRO, the plan administrator must
provide the following information to the participant and alternate
payee:
- The reasons why the order is not a QDRO;
- References to the plan provisions on which the determination is
based;
- An explanation of any time limits that apply; and
- A description of any additional information or modifications
necessary for the order to be a QDRO and an explanation as to why it is
necessary.
As a practical matter, the plan administrator will ordinarily contact
its pension and/or legal advisors for confirmation that the court order is
a valid QDRO and for assistance in complying with both the procedural
notice requirements and implementation of the QDRO.
Access to Plan Information
The plan administrator must provide prospective alternate payees who
are involved in a domestic relations order proceeding access to plan and
participant benefit information sufficient to prepare a QDRO, such as the
summary plan description, a copy of the plan document and a statement of
the participant's benefit entitlement.
The plan administrator may condition disclosure of such information to
a prospective alternate payee on some reasonable basis for concluding that
the request for information is being made in connection with a domestic
relations proceeding.
When Benefits Can Start
In general, pension law does not require payments to begin to an
alternate payee until the "earliest retirement age" of the participant,
defined as the earlier of two dates:
- The date the participant is entitled to a withdrawal 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.
Such payments are permitted even though the participant is still
employed at the time and intends to remain employed in the future.
Plan documents or written QDRO procedures may permit earlier
distribution of benefits to the alternate payee. Many plans avail
themselves of the opportunity to provide immediate cash-out of alternate
payee benefits in order to avoid the need for segregated accounts,
extended division of present and future benefits and other administrative
headaches.
Division of Benefits
The method used for dividing the retirement benefits payable to an
alternate payee will depend upon whether the plan is a defined benefit
plan or a defined contribution plan.
Defined Benefit Plans
Generally, a defined benefit plan provides a specific benefit
determined and payable at retirement. The benefit is usually determined
based upon factors such as years of service and compensation of the
participant, and is payable in the form of a monthly benefit.
Because of the nature of the benefits provided by defined benefit
plans, division of such benefits in divorce proceedings may raise complex
issues. Benefits may have not yet fully vested in the participant, and
there may be substantial future accruals which may or may not be taken
into account under the QDRO. Valuation of defined benefit amounts may be
based on a variety of methods.
Many defined benefit plans do not allow lump sum payouts to alternate
payees. Therefore, the alternate payee must accept an annuity form of
benefit, which may not be payable until the participant is entitled to
retirement benefits.
Defined Contribution Plans
Instead of promising a future benefit like defined benefit plans,
defined contribution plans provide an individual account for each
participant. The account grows through employer and/or employee
contributions, earnings and, in some cases, forfeitures from the nonvested
portion of the accounts of terminated participants that are reallocated to
the remaining participants.
For defined contribution plans, the alternate payee generally receives
a percentage of the participant's vested account balance (such as 50%) as
of a particular date, although a dollar amount may be specified. If the
parties agree as to the division fraction and if immediate distribution is
permitted and selected, the only remaining issue may be how currently to
value the alternate payee's interest since many defined contribution plans
are not valued on a daily basis.
Tax Treatment
Payments to a participant's spouse or former spouse are taxable to the
spouse. The spouse or former spouse of the participant may elect to have
all or a portion of a lump sum payment pursuant to the QDRO directly
rolled over to an IRA or another qualified retirement plan, thereby
deferring the tax. Any portion not rolled over is generally subject to
federal income tax as well as any applicable state income tax but not the
10% early withdrawal penalty.
Distributions to other alternate payees, such as the child of the
participant, are taxed as income to the participant, may not be rolled
over and are not subject to the 10% early withdrawal penalty.
Modifying QDRO Benefits
Earlier this year, the DOL issued Advisory Opinion 2004-02A regarding
modifications made by a court to an existing QDRO. This guidance states
that a new domestic relations order covering the same parties can alter a
prior one so long as the new order meets the qualification requirements
for a QDRO. Generally, the changes would only apply to future payments.
Allocating QDRO Expenses
In May 2003, the Department of Labor (DOL) issued Field Assistance
Bulletin (FAB) 2003-3, which completely reversed its prior position
regarding charging an individual participant's account for the fees
related to a determination of the validity of the participant's QDRO.
Prior to FAB 2003-3, plans were permitted to pass on QDRO determination
expenses to the plan as a whole but not directly to the account of the
participant involved in the QDRO. Plans are now permitted to allocate
reasonable expenses associated with QDRO determinations directly to the
participant's account.
In order to take advantage of the DOL's new position, the plan's
document may need to be amended to include specific provisions for the
allocation of expenses. In addition, plans must include information in the
summary plan description concerning any expenses that could be charged
against a participant's account.
Conclusion
QDROs require special language and should be carefully reviewed to make
sure they meet the requirements of the law and are administrable under the
terms of the plan. The protection afforded by the federal government to a
divorcing spouse adds one more administrative chore for the plan
administrator. But with proper consulting and legal advice, the plan can
handle QDROs without a great deal of strain.
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