Bar News - November 19, 2014
Family Law: QDROs: Avoid Common Pitfalls When Dividing Retirement Benefits
By: Jaime Gillis
The division of retirement assets in divorce cases requires a high level of diligence and care to ensure compliance with state domestic relations law, the Employee Retirement Income Security Act (ERISA), the Internal Revenue Code (IRC) and individual plan requirements, all while accurately representing the intent of the parties.
A qualified domestic relations order (QDRO) is required to divide any plan subject to ERISA. To have effect and avoid tax penalties, the QDRO must be approved by the court and also satisfy certain basic criteria to be deemed qualified by the plan’s administrator.
If improperly drafted, a QDRO may have an abruptly disastrous outcome in the future. A QDRO may meet the minimum requirements for plan and court approval while still failing to accurately reflect the intent of the parties. The omission of certain discretionary provisions can severely limit, or extinguish altogether, an alternate payee’s assigned benefit, and the impact of the omission may not be understood until many years after the divorce, when the participant retires or dies.
The following is a discussion of some common mistakes made when drafting a QDRO and ways to avoid them.
Failing to include essential features in the separation agreement. A QDRO should reflect the terms of the separation agreement. Unfortunately, too often a separation agreement will contain only one sentence regarding the division of retirement benefits, concisely stating the essence of the agreement, but vague enough to leave other essential features, such as survivorship rights and the assignment of value-added benefits, open to interpretation. By including comprehensive and definitive provisions for the division of retirement benefits in the separation agreement, disputes over the terms of the QDRO may be avoided.
Arbitrarily using the plan’s model QDRO. Widespread participation in retirement plans has resulted in a higher standard of care being imposed upon QDRO preparers, some of whom rely upon company model QDROs to relieve themselves of this burden. Model QDROs exist primarily for the administrative convenience of the plan. Their use may expedite the qualification of an order, but they should be scrutinized and modified where necessary to ensure the terms are consistent with the intent of the parties.
Assuming every plan is ERISA-governed. A common misconception is that a QDRO is the appropriate instrument to effect division of all retirement benefits. In actuality many plans are exempt from ERISA, such as individual retirement accounts which can generally be divided with a simple “Letter of Instruction” in lieu of a QDRO. State governmental plans, military retired pay, and federal government retirement plans are likewise exempt and have their own specific informational requirements that are beyond the scope of this article. The form and substance of an order differs drastically depending on the type of plan involved. The plan’s summary documents should be referenced to identify the correct plan type.
Failing to timely draft the QDRO. Events such as early retirement, termination of employment, and death may render certain QDRO provisions unenforceable if they occur before a QDRO is prepared. Recognizing that time is of the essence, it is advisable to draft a QDRO concurrently with the separation agreement and incorporate it into the divorce decree.
Failing to provide survivorship protection. Without preretirement and postretirement survivorship protection an alternate payee’s benefit is unsecure and may terminate upon the death of the plan participant. Granting survivorship benefits in the QDRO is critical if the parties intend to provide lifetime benefits to the alternate payee of a defined benefit plan. If the participant is retired, the survivorship elections will have already been made and must be taken into consideration when negotiating the separation agreement.
Using imprecise language to assign benefits. A plan administrator cannot accurately calculate the assigned benefit without precise instructions. With respect to defined benefit pension plans, orders should therefore clearly establish: the coverture formula for calculation of the accrued benefit; and whether payments will be paid over the life expectancy of the participant (shared payment) or the alternate payee (separate interest).
With respect to defined contribution plans such as 401(k) plans, orders should establish: the effective date of the assignment; whether investment gains/losses are to be applied to the assigned benefits from the effective date until distribution; the effect of any loans taken by the participant; and whether future employer discretionary contributions should be included in the division.
Failing to assign value-added benefits. Benefits ancillary to the assigned benefit may represent a valuable portion of the benefit and are often overlooked. The separation agreement and QDRO should specifically state whether any portion of cost-of-living adjustments or early retirement incentives are to be assigned.
Clarity is key in ensuring the equitable division of retirement benefits, both in the wording of the QDRO and in the understanding of the parties of the benefits to be received and assigned.
Jaime Gillis is a member of the Estate Planning and Probate Practice Group at Primmer Piper Eggleston & Cramer. She has more than a decade of experience counseling clients on estate planning, estate and trust administration, business succession planning and post-divorce retirement plan division by QDRO matters.