An In Depth Look Into Common QDRO Mistakes

Divorce is a time for caution when dividing a pension that is part of the marital estate. In most cases, dividing a pension requires a Domestic Relations Order (DRO) or Qualified Domestic Relations Order (QDRO) that must be properly prepared, approved by the pension plan administrator, and issued as a court order. In many cases, dividing a pension means the equitable distribution of the breadwinning husband’s pension in favor of his homemaking wife. Mistakes can have drastic consequences for a woman who stayed home to raise the children and who now goes into her Golden Years dependent on her fair share of his retirement benefits.

In many divorces, the retirement plans – particularly the pension plan of the husband – are the couple’s most significant marital asset, so divorce practitioner must understand the terms and conditions of the plans. The lawyer must take the time to gather the necessary information about the plan. A (Q)DRO executed contemporaneously with a divorce judgment and required by the terms of the judgment becomes part of the property settlement.

Many, if not most, women defer to their lawyers and incorrectly assume that they know all about the many federal and state laws that set the rules for dividing pensions. Pension law and QDROs are among the most complex and difficult parts of family law, and they can take some lawyers to the periphery of their abilities.

Most pensions are termed “qualified” under the Employee Retirement Income Security Act (ERISA), a federal law that establishes minimum standards for private industry pension plans and provides for extensive rules on the federal income tax effects of transactions associated with employee benefit plans.

Unfortunately, many lawyers either do not know or do not take the time to find out all the information needed to prepare a pension order that will be acceptable to the pension plan and fully protect the wife’s interests. They also don’t explain all her rights and options in collecting her pension share. Other lawyers don’t follow up to make sure that pension plan officials receive and approve the final pension order promptly after the divorce is final. These QDRO missteps can have drastic consequences.

The Woman’s Institute for a Secure Retirement (WISER) sets forth a catalogue of common mistakes divorce practitioners make regarding pensions – errors that are particularly damaging to women. The long-term interests of a middle-aged woman going into divorce can be comprised by a lawyer who:

  • fails to ask for the important information about a spouse’s benefits and retirement soon enough. Pension plans vary greater in regards to the terms and conditions of when a pension can be paid under a domestic relations order.
  • fails to prepare any pension order. This should be done at time of the divorce. The death of a former spouse, his retirement or remarriage can reduce the benefits a former spouse otherwise would have received.
  • fails to obtain information about every retirement benefit that might be marital property. Many employees have more than one pension plan at the same company. Some people have pensions from companies where they no longer work.
  • fails to obtain information about all pension plans provisions. Benefits vary greatly, and some plans pay more than one type of benefit. For example, some include cost of living escalators, and others have provisions to encourage early retirement.
  • fails to ask for survivor benefit or does not mention that none are available. The death of a worker-spouse may terminate the benefits depending on the terms of the plan and the DRO and the election made by the worker-spouse upon retirement.
  • fails to explain how retirement benefits are usually divided under state law. State marital and community property laws often specify the division and distribution of retirement and pension benefits. Sometimes couples can use these laws as the basis of negotiation.
  • fails to explain what a former spouse might do to reduce or eliminate benefits to the former partner. Sometimes a former partner may fail to apply for a pension or waive his right to a pension or become injured or disabled.
  • fails to explain how remarriage might affect benefits. Some federal, state and local government employee benefits terminate if the former wife remarries.
  • fails to explore the unusual legal requirements or loopholes that could result in the pension order being rejected by the plan administrator. Some plans are not required to accept any court order assigning benefits to a former spouse.

According to the American Bar Association, Family Law Section, there are 10 top QDRO mistakes that even experienced lawyers make. These include:

Misunderstanding the type of plan to be divided.

Pensions plans are of three basic types: Defined Contribution Plans (DC plan), Defined Benefit Plans (DB plan) and Cash Balance Plans (CB plan). In a DC plan the worker makes pre-tax contributions (or after-tax contributions in the case of Roth 401(k) plans) to an account in his name (such as a 401(k)), but there is no guarantee how much money will be in the account at retirement. In a DB plan (the old fashioned “company pension”) there is no specific account maintained for a participant who works understanding that he will receive a monthly benefit upon retirement. CB plan are DB plans with features similar to DC plan.

The language in the settlement agreement and QDRO should be applicable to the type of retirement benefits being divided. There are two main types of retirement plans, namely 1) Defined Contribution Plans (DC plan) and 2) Defined Benefit Plans (DB plan). 401(k), 403(b), and 457 deferred compensation plans are DC Plans. The benefits under DC plans are based upon actual monetary contributions to the plan, and the investment performance of the contributions; the benefits under traditional DB plans are paid as a monthly annuity based on a formula tied to the participant’s years of service, final salary, and age at retirement. The benefits paid under a traditional DB plan are not solely based on the monetary contributions made to the plan. DC and DB plan are different animals, and the language defining them is different.

The language dividing DC plans should:

  • refer to participant’s total account balance;>
  • express the alternate payee’s interest as either a dollar amount or percentage of the account, as of a particular valuation date, which is usually the parties’ separation date, date of the filing or date of divorce;
  • address whether the alternate payee’s share should or should not be adjusted for interest or investment earnings;
  • address whether the alternate payee’s share should or should not be affected by any outstanding loan balance;
  • provide for a new account to be created in the Alternate Payee’s name;
  • provide the option of an immediate distribution or rollover of Alternate Payee’s share.
At the same time, the language dividing DC plans should not
  • refer to the coverture formula;
  • refer to the participant’s accrued benefit;
  • provide for a monthly benefit;
  • refer to COLAs or early retirement subsidies;
  • address survivor benefits;
  • delay the alternate payee’s benefit commencement until the participant is eligible for retirement or actually retires.

In short, the language that should be used to divide a DC plan should not be used to divide a traditional DB plan, and the language that should not be used to divide a DC plan should be used to divide a traditional DB plan. The language used to divide a CB plan depends on the requirement of the plan.

Attempting to divide nondivisible plans.

Retirement plans and assets that are not included under ERISA cannot be divided by a QDRO. “One of the most difficult post-divorce situations to deal with is when the parties discover, after the final judgment (in some cases, several years after the divorce), that one of the retirement assets they have agreed to divide is simply not divisible or assignment,” says the ABA. Moreover, Individual Retirement Accounts (IRAs) do not require a QDRO. However, care must be taken in splitting an IRA. Normally, distributions from a retirement plan prior to age 59 1/2 are considered early distributions and are subject to a 10 percent penalty tax in addition to ordinary income tax. A transfer of the retirement plan (or a portion of it) to a spouse as part of a divorce settlement is exempt from this rule, however.

Failing to use the correct name of the plan.

The proper name plan can tell where the plan is a DC plan or a DB plan. Moreover, according to the ABA, since workers often are covered by more than one plan, “it pays to find out in advance the exact names of all the plans in which the employee spouse participates.”

Failing to set a clear date of division.

“Many settlement agreements fail to state a precise date for the division of retirement assets, which creates quite a bit of QDRO litigation.” A great deal of money can be at stake. “In a defined contribution plan, if the market spikes up or down during this period, and the agreement is not specific, the parties may fight relentlessly over which date should control.”

Failing to address earnings and losses in a DC plan.

Often there is a delay of several months between the date of division and the date that funds in a DC plan are divided. The Agreement must specify what happens to earnings and losses awarded to the wife between the date of division and actual payment.

Failing to address surviving spouses issues.

Practitioners often neglect to spell out both pre- and post-retirement surviving spouse coverage in the Settlement Agreement. Surviving spouse benefit are particularly complex, especially in defined benefit plans. The Agreement should address whether the alternate payee is to be considered the surviving spouse if the worker dies before the transfer under the QDRO is finished.

Messing up the “equalization” of multiple plans.

When spouses have several DC plans, lawyers sometimes try to save money by combining the values of all of the DC plans and transferring an equalizing amount to one account. This can work, provided that both the parties exchange statement for each account on a specific date and set forth in the agreement how the calculation is to be completed.

Experienced QDRO lawyers do not try to “equalize” DB plans. Each DB plan requires its own QDRO.

Ignoring loan balances.

Loan balances in DC plans are often overlooked because some plans make it hard to determine if he account has an existing loan balance. Most DC plans consider a loan an asset that is part of the total value of the account; however, most plans can award any portion of the loan balance by way of a QDRO.

Failing to stipulate who is responsible for drafting the QDRO.

Hard as it may be to believe, some separation agreements fail to assign responsibility for drafting a QDRO. “QDROs can easily fall through the cracks, since they are not something most clients are familiar with, and each attorney may assume the other is taking care of it and then forget about it as time passes,” says the ABA. “…[T]his means the QDRO is never drafted or completed.”

Failing to implement the QDRO.

The diligent practitioner should never close the file on a QDRO until he or she has received certification from the plan administrator that the final QDRO has been received and accepted. This is true regardless of which attorney drafted the QDRO.

In addition to proper QDRO preparation, proper timing prevents adverse financial consequences and hardships that can otherwise happen. Ideally, the QDRO should be prepared as soon as the parties have reached a basic settlement regarding the division of the retirement asset. In a divorce, the ideal way to address the division of a qualified retirement account upon divorce is to prepare the QDRO concurrently with the settlement agreement and incorporate it by reference in the settlement agreement.

This means the QDRO is filed concurrently with the Judgment of Dissolution. Otherwise, the QDRO should be prepared as soon to the time of divorce as possible.

The alternate payee must be mindful of the risks she runs if the QDRO is not filed. The alternate payee may entirely lose his/her benefits if the participant:

  • terminates employment and takes a full plan distribution under a DC plan;
  • retires and begins commencement of benefits without notifying the alternate payee, including losing rights to a pre-retirement survivor annuity, losing rights to a separate interest lifetime pension, losing rights to a coverture-based pension, and losing rights to an early retirement subsidy;
  • dies without a QDRO in place securing survivor benefits for the alternate payee, including losing all of his or her pension;
  • takes a loan that which significantly reduces the account balance available for division.

The timely incorporation of a QDRO protects against bad outcomes in the division of the popular 401(k) plans that include losing investment gains, losing entire assignment if participant quits and takes distribution, losing the entire assignment if participant dies and losing rights to name beneficiary upon her own death.

Sometimes plan administrators change while parties wait to draft the QDRO. This can create significant problems if the parties do not have their own plan statements for the time period from the date of marriage to date of separation. When the new plan administrator takes over, he or she faces a blind spot in benefits accrued prior to his or her administration. For example, if the parties’ separated in 2005 and the plan administrator changed in 2007, he or she may reject a QDRO with a valuation date in 2005. In this event, the parties may need to retain an actuary or accountant to perform a calculation to determine the community property interest in the benefits.

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