CCH-EXP, PEN-PORTFOLIO , Drafting the
Division of Retirement Plan Assets into a
Divorce Decree - Qualified Domestic
Relations Orders
Drafting the Division of Retirement Plan Assets into a Divorce Decree -
Qualified Domestic Relations Orders
by Steven H. Leventhal, J.D., LL.M., Taxation
Steven H. Leventhal, J.D., LL.M. Taxation, is an attorney in Bend, Oregon. He specializes in all
areas of federal and state pension law, including advising and drafting Qualified Domestic
Relations Orders; estate, tax, and business planning; probate; and guardianships and
conservatorships. He is a member of the American Bar Association Section on Estate Planning,
the WealthCounsel LLC, and Oregon State Bar Sections on Taxation, Elder Law, Estate
Planning, Business Law, and Taxation. Mr. Leventhal is a former supervisory attorney at the
IRS Employee Plans Division in Washington, DC. He may be contacted at
www.steveleventhal.com.
[[ This article was revised after the date of publication in the fall of 2004 ]].
Almost every divorce has retirement plan assets to be divided between the parties.
These assets may be held in a 401(k), profit-sharing, defined benefit pension plan, money
purchase pension plan, 403(b)-plan, or Individual Retirement Account or Individual
Retirement Annuity. It is essential to protecting each client's interest in the divorce that the
attorneys - especially the attorney for the non-participant spouse - have a thorough
understanding of the retirement plan(s) in question as they negotiate a division of benefits.
Nothing - well perhaps some things as we will see below - can be potentially worse that
blindly dividing a retirement benefit and simply inserting that division into a divorce
decree.
I had 20 years of pension experience when I set up my private law practice in Oregon
in 2002 and began advising attorneys on the division of retirement benefits in divorce and
drafting Qualified Domestic Relations Orders (QDROs) and the government equivalents.
What I quickly learned was how many truly competent divorce attorneys did not understand
the QDRO process and also how important it was for even experienced benefits attorneys
like myself to follow this process with a clear attention to detail. This article will highlight
some of the more prominent traps I have seen in my QDRO practice.
QDRO Article Published by CCH, Inc. -- 1
STATUTORY BACKGROUND
Under ERISA, qualified retirement plans - such as traditional pension, profit-sharing,
money purchase, and 401(k) plans - must specifically contain a spendthrift provision that
provides that benefits in the plan can not be assigned or alienated. IRC Sec. 401(a)(13), as
added by the Employee Retirement Income Security Act of 1974 (ERISA). An exception to this
rule is a distribution pursuant to a Qualified Domestic Relations Order as defined in IRC
Sec. 414(p). A distribution from a single participant non-ERISA 403(b)-plan (tax-sheltered
annuity) pursuant to a domestic relations order is treated in the same manner as a qualified
retirement plan under IRC Sec. 401(a)(13). See IRC Sec. 414(p)(9) and (10). A 403(b)-plan that
is subject to ERISA Title I is covered by both the IRC and ERISA Sec. 206(d).
Prior to 1984 there were a number of court cases regarding IRC Sec. 401(a)(13) and
ERISA Sec. 206(d), and state court-ordered decrees that required payments from an
employee's pension plan of alimony and child support obligations. The drift of the cases was
that ERISA was not intended to pre-empt state domestic relations laws permitting the
attachment of vested benefits for the purpose of meeting those obligations. See, e.g., AT&T v.
Merry, 592 F.2d 118 (CA-2 1979).
Similarly, the IRS had issued rulings up to that time which held that the spendthrift
provisions of IRC Sec. 401(a)(13) were not violated when a plan trustee complied with a court
order that required a distribution of benefits of a plan participant in pay status to the
participant's spouse or children to meet the participant's alimony or child support payments.
However, the IRS also held in that same ruling that accrued benefits that are not currently
payable to the participant under the plan's terms could not be attached since the participant
had no present right to the benefits. IRS Rev. Rul. 80-27, 1980-1 CB 85.
This was a deal breaker because many plan participants involved in a divorce are not
in pay status; i.e., they are not either currently receiving a benefit or they are not entitled to
receive a benefit at this point in time.
The Retirement Equity Act of 1984 did three things regarding the spendthrift
provisions under qualified retirement plans:
1. Created an entirely new set of rules for the treatment of certain domestic relations
orders under IRC Sec. 414(p) and ERISA Sec. 206(d).
2. Provided a set of procedures for plan administrators to follow with respect to
domestic relations orders.
3. Provided that the broad federal pre-emption provisions of ERISA do not apply to
domestic relations orders and therefore the enforcement of state domestic relations orders
QDRO Article Published by CCH, Inc. -- 2
was allowed.
A Domestic Relations Order under IRC Sec. 414(p) is a judgment, decree or order
(including approval of a property settlement agreement) made pursuant to a state's domestic
relations or community property law and relating to the provision of child support, alimony
or marital property rights to a spouse, former spouse, child or other dependent of a plan
participant. IRS Sec. 414(p)(1)(B) and ERISA Sec. 206(d)(3)(B)(ii). The Domestic Relations
Order becomes "Qualified" when it is later formally approved by the plan administrator.
IRC Sec. 401(a)(13) and 414(p) and ERISA Sec. 206(d) provide the rules for defining a
domestic relations order and stating what may or may not be acceptable language for such an
Order. ERISA Sec. 206(d) additionally provides rules for an ERISA plan administrator to
follow in determining the "qualified" status of a domestic relations order.
ROLE AND TRAPS FOR THE ATTORNEY
The real issue for divorce attorneys is making certain that the language they include
in a divorce decree and a QDRO protects their client. For all practical purposes, IRC Secs.
401(a)(13) and 414(p) and ERISA Sec. 206(d) mean very little to the attorney who is attempting
to negotiate a favorable division of a retirement asset for his client.
The problem, however, is that most divorce attorneys – and this is not about
competency as a divorce attorney – do not know the intricacies of retirement benefits law, do
not understand retirement plan language and how it impacts on the ultimate benefit to be
received by a plan participant or Alternate Payee, almost never even read the plan or plan
procedures, don't know what a vesting schedule means and how it might impact on a
division of benefits, have no idea how plan loans reduce an existing account balance, and
then get caught in one of the worst traps of all – using a plan administrator's model QDRO to
protect the interest of his client.
This area is so complex that even seasoned benefit attorneys, such as myself,
approach each case with caution and detail. Let me address some of the problems I have seen
in my QDRO practice and what I recommend as a way to avoid the pitfalls.
NEVER EVER USE A PLAN ADMINISTRATOR'S MODEL QDRO
Many plan administrators will tell the divorce attorney to use their model QDRO.
This should never be done. Everything the plan administrator needs is in their model
language. What your clients need is something else and much more extensive, and the
QDRO must be tailor-made for the client.
Under ERISA Title I, the plan administrator's obligation is to comply with its
statutory obligation under federal pension law. Beyond that obligation, there is no statutory
QDRO Article Published by CCH, Inc. -- 3
responsibility to either party in the divorce. While some of the model language will benefit
the parties, a model QDRO is not drafted with the interests of either the plan participant or
Alternate Payee in mind. A model QDRO is simply not drafted to protect the client -
whether the plan participant or Alternate Payee - the way the client has been protected by
their divorce attorney throughout the divorce process.
A model QDRO should be reviewed to make certain that the plan administrator's
requirements are met and then they should be incorporated into a “real” QDRO along with
those clauses that actually protect the client.
Most model QDRO language is developed for defined benefit pension plans. This is
more likely where these pension plans are union negotiated. These model QDROs generally
do not have language creating a "separate interest" approach (whereby the Alternate Payee’s
benefits are separated from the Plan Participant) or "share interest" approach (whereby the
Alternate Payee is still tied to the coat-tails of the Plan Participant) under a defined benefit
pension plan. The parties have to decide which approach is best for their clients and this
should be decided in advance of the signed judgment.
This decision is critical and, if appropriate language is omitted by the attorney, this
can be devastating to a client's interest. In addition, most model QDROs do not include
language regarding benefits at early retirement or early retirement subsidies, cost-of-living
adjustments or other changes in benefits, the method of dividing benefits, protection to the
Alternate Payee from a manipulative plan participant-spouse, protection in the event of
death, beneficiary designations, and other protective clauses.
Verbatim acceptance of a model QDRO will not protect your client. A QDRO must
be drafted and tailored to your client's needs. The best approach is to bring the QDRO
attorney into the process while the division of property is being negotiated. This will make
certain that the parties’ wishes regarding the division of retirement plan assets can ultimately
be achieved.
VESTING SCHEDULES MUST ALWAYS BE TAKEN INTO ACCOUNT
What looks simple on its face is often where the worst traps lay. This occurs with the
division of a defined contribution plan where the parties agree to split the account balance as
of a date certain and both parties believe they will be getting the dollar amount reflected by
the percentage split. If the participant is less than 100% vested and the attorney for the
Alternate Payee does not take the vesting schedule into account the Alternate Payee will be
in for a rude awakening. Here is how it plays out.
Example: Assume there is $110,000 with the account balance to be divided 50/50 as of
December 31, 2004. Of that amount, $70,000 is in elective deferrals and $40,000, is in
employer contributions. As of 12/31/04, employer contributions are 60% vested. Sally is
QDRO Article Published by CCH, Inc. -- 4
dreaming of $55,000, but dream on. She will get less.
First, take the $70,000 in elective deferrals and divide it by 50%. Sally gets $35,000,
because elective deferrals are always 100% vested.
Second, take the $40,000, in employer contributions and divide it by 50%. That gives
Sally $20,000. BUT there is one more step. Sally will get only 60% x $20,000, which is $12,000.
She only gets $12,000, because employer contributions in the year of division are 60% vested.
Her ex keeps the difference between the $20,000 and $12,000 in his retirement account. If the
Participant separates from service in 2005 and his account balance in employer contributions
is still 60% vested, he too will receive only $12,000, from this account. The remaining $8,000
will be forfeited and re-allocated to the other plan participants.
So Sally gets $35,000 + $12,000 = $47,000; not $55,000. If the plan administrator allows
Sally to stay in the plan as an Alternate Payee and the Participant also remains in the plan, as
the vesting schedule increases to 100%, Sally's share will eventually become 100% vested.
FAILURE OF PROPER DISCOVERY
One of the worst omissions is the failure to request proper discovery during the
beginning of the divorce proceedings. If you represent the non-participant spouse you need
to learn everything you can about the other party's retirement plans. Too often a judgment of
divorce d will simply divide a retirement plan by a dollar or percentage amount without
taking into account any other factors. This is a disaster waiting to happen for the Alternate
Payee.
At a minimum a divorce attorney for the Alternate Payee should request the
following information:
1. The type and name of each retirement or deferred compensation plan in which the
party is a plan participant, including but not limited to pension plans, 401(k) and profit-
sharing plans, any governmental retirement plan, tax-sheltered annuities (403(b)-plans), and
IRAs.
2. The name, address, and telephone number of the plan administrator for each
retirement or deferred compensation plan.
3. The most recent account balance or annual statement, whichever is appropriate for
the particular plan, including a statement of any outstanding plan loans.
4. Copy of the Summary Plan Description.
5. Any actuarial evaluations performed by the plan administrator or an independent
QDRO Article Published by CCH, Inc. -- 5
party regarding the other party's accrued benefit, including the right to, and amount of, early
retirement benefits.
6. Whatever else you think is appropriate in a given case.
When you have this information, you will have a pretty good picture of the other
party's retirement benefits and the potential share for your client as Alternate Payee. You
should also make sure you have a court order prohibiting the other party from changing
investments without your consent or taking any distributions or loans from the plan(s) while
the divorce is pending.
When you do gather this information from the plan administrator, you will learn:
1. What kind of plans the parties have.
2. If a defined contribution plan, how much is in the account balance. If a defined
benefit plan, what is the accrued benefit.
3. If a defined contribution plan, whether the account is made up of elective deferrals
alone or together with employer contributions.
4. If there are employer contributions, the extent to which they are vested (or non-
forfeitable).
5. If there are employer contributions, whether outstanding forfeitures of other
employee/plan participants have been re-allocated to your client's account or may be re-
allocated in the following year BUT are attributable to the period covered by the division of
the retirement benefit.
6. Whether any loans exist and the terms of repayment.
7. The number of years (including fractional years) in which your client was a plan
participant and how many years (including fractional years) she was married to her current
spouse during the period she was a plan participant.
By having this information, you can adjust your negotiating strategy accordingly.
QDRO ADMINISTRATORS OFTEN DON'T KNOW PENSION LAW
Never – ever – fully trust a QDRO administrator. Always be courteous and respectful
to the QDRO administrator because they have all the control. And they also have
information regarding account balances/annual statements, Summary Plan Descriptions,
QDRO procedures, and generally how the plan works.
QDRO Article Published by CCH, Inc. -- 6
But never fully trust them because generally they do not have complete knowledge
about QDROs or nor will they tell you how to draft a judgment in order to best protect your
client’s interests. They may know the plan, but they often do not know federal pension law.
The absolute worst case of QDRO administrator incompetence was where I was retained to
review a QDRO drafted by another attorney.
The QDRO – a model QDRO provided by the QDRO administrator to the
attorney – was drafted as if the plan was a defined contribution plan. After I reviewed the
Summary Plan Description I learned that the plan was a defined benefit plan; not a defined
contribution plan. By the way, when I was brought into the case by the Alternate Payee, this
QDRO administrator had already pre-approved the QDRO.
I called the QDRO administrator and asked him how he could have approved the
QDRO when it was drafted for a defined contribution plan. He told me that I should not
worry because he would administer the QDRO as if it was written for a defined benefit plan.
When I told him that he could only administer a QDRO as written and then asked for the
head of his department, he finally relented.
Most QDRO administrators are competent and helpful. But they do not represent
your client. You do. I would add that the attorney who drafted the QDRO used the Model
Language provided by the plan administrator and acted at his direction. This particular
attorney – who also does not do divorce work – is highly capable attorney in many areas of
the law, but he did not have benefits or QDRO experience. This was not about his
competence. Rather it is about the complexity of the area of benefits law and QDRO
drafting.
CIVIL SERVICE RETIREMENT SYSTEM
The CSRS is a monster and requires careful review before any judgment of divorce is
signed. Two of the worst failures under the CSRS that I have seen are (1) the failure to
provide for a former spouse survivor annuity in the judgment of divorce and (2) the failure to
make certain that the non-participant spouse has continued health coverage after the divorce.
A "Court Order Acceptable for Processing" (COAP for short) is the term for a Court
Order dividing a CSRS benefit. If the Former Spouse has an expectation that she will
continue to have a retirement benefit until her spouse’s death, the judgment of divorce must
set forth language providing for a former spouse survivor annuity. The COAP can not be the
first document to provide the survivor annuity. If the judgment of divorce does not contain
this language, OPM will reject the survivor annuity. Try explaining that to your client.
While health benefit coverage is not a COAP issue, it is essential that the divorce
attorney explore post-divorce health coverage for the non-participant spouse. Sec. 8901 et
seq. of Title 5, U.S.C. The former spouse can not continue under the Employee's coverage
QDRO Article Published by CCH, Inc. -- 7
because she is no longer a family member. However she can sign up for continued health
coverage in her own right if she meets the following criteria:
1. She must have been a family member under the Employee's/Retiree's health
enrollment for at least one day during the 18 months prior to divorce.
2. She must be entitled to receive a portion of the annuity after the Employee retires
or a survivor annuity at the time the Employee/Retiree dies.
3. Within 60 days after the divorce, she must apply for continued health coverage in
her own right.
4. She can not remarry prior to age 55.
Both these issues are critical to the Former Spouse and must be negotiated during the
divorce process. Waiting until after the divorce can be fatal to your client's interests.
CONCLUSION
Drafting QDROs requires thorough discovery, advance planning, a complete review
of plan documents and statements, and a thorough understanding of federal (and state)
benefits law. All this must be done prior to the time the judgment of divorce is finalized. A
QDRO should always be drafted by a professional skilled in this area of law and, whenever
possible, before the judgment of divorce is finalized. Once the judgment is finalized, it is
almost always too late to correct errors or omissions that should have caught prior to the
judgment of divorce being finalized.
QDRO Article Published by CCH, Inc. -- 8