One of the largest assets in most divorce cases is the retirement accounts held by the parties. Not all retirement plans are the same and it is important for an attorney to understand what types of retirement plans a QDRO can (and cannot) divide.
A QDRO is a qualified domestic relations order and is necessary to divide all qualified retirement plans. Qualified plans are those plans that are governed by the Employee Retirement Income Security Act of 1974 (ERISA).These plans receive special tax-qualified treatment and employers who maintain them must comply with ERISA guidelines. Qualified plans include 401k’s, 403b’s, 457 plans, profit sharing plans, and qualified defined benefit pension plans.
The simplest type of qualified retirement plan is a defined contribution plan. In this type of plan, the employee (and sometimes the employer) puts money away on a pre-tax basis into an investment account that will grow (hopefully) tax deferred until retirement. This is important, because when determining how to equitably divide the martial estate, counsel must take into consideration the difference in value between pre and post-tax assets. Having a $100,000 401(k) account (pre-tax) is not the same as having a $100,000 after-tax savings account. This is so because the retirement account funds will be taxed when they are removed from the account. Thus, attorneys should think about (and negotiate for) what tax rate should be considered in relation to the retirement funds, and make adjustments in the division of the estate accordingly. For example, if the parties are dividing the $100K retirement and savings account, the amount of cash from savings awarded to the spouse receiving a share of the retirement via QDRO should be adjusted to make up for the 23% income tax (or whatever rate should be considered) on that spouse’s share of the retirement account when taken.
The spouse receiving her share of retirement via QDRO is deemed the alternate payee, and depending upon the plan administrator’s policy, may usually roll her share over into her own account or take a lump sum distribution. Taking a lump sum distribution prior to pre-59 ½ distributions via QDRO is the only time the alternate payee can avoid the 10% penalty under IRS Regulation 72tc. It is important to recognize that this benefit is only available to the alternate payee, not the spouse retaining the balance of the retirement (the participant). And it does not apply if the alternate payee rolls the account over into a separate retirement account first.
Tax advantaged plans, like IRA’s, can’t be divided via QDRO and the ability to take a lump sum without incurring the 10% penalty does not apply to these types of plans. Each IRA plan typically has its own transfer forms for dividing accounts pursuant to divorce. An attorney should be sure to get this information from the IRA administrator well in advance of entering a final judgment to ensure smooth transfer of funds after divorce.
Other issues to be addressed in a QDRO are the date of division, whether to consider market gains/losses from date of division to date of distribution, designation of survivor benefits, whether the alternate payee will receive cost of living and other post retirement increases, etc. All of these are important issues that must be decided prior to drafting the QDRO to avoid surprises and unhappy clients at the time of retirement.
NEXT TIME: Dividing Pensions via QDRO.