One little known use of QDROs is to provide a security interest in a participant’s qualified plan benefits to the non-participant spouse.
Often in divorce settlements, security interests are granted in property awarded to the other spouse. This happens when there is a disproportionate division of community property and parties attempt to equalize the division by awarding one spouse a note for the difference. A note without security is an unsecured promise to pay, however, and it is at risk of the claims of other creditors on par with the spouse.
Security interests are especially useful in securing what are called “equalization notes.” Generally, other than for the security of plan loans, a participant’s plan benefits are not subject to assignments. However, QDROs are the “gateway” through the anti-alienation provisions of IRC Section 401(a)(13). Section 401(a)(13) is the anti-assignment rule that prohibits the assignment of a participant’s retirement benefits to anyone.
Section 1.401(a)-13(c)(1)(ii) of the IRC regulations defines “assignment” broadly to include any indirect arrangement in which a party, such as a spouse, acquires from a participant, a right enforceable against the plan in all or any part of a plan’s benefits payable to the participant. A security arrangement between spouses regarding plan benefits is an assignment normally prohibited by Section 401(a)(13)(A). Section 401(a)(13)(B), however, provides that an assignment normally prohibited may be made, if the assignment is made pursuant to a QDRO. Such assignments can be made only for the benefit of an alternate payee, and these assignments do not provide any additional benefit to third party creditors.
When considering the use of a QDRO to provide for a security interest, the alternate payee and his or her lawyer must remember tax consequences, That is, if the QDRO provides that the alternate payee (who is a spouse or former spouse of the participant) can force a distribution from the plan to satisfy the debt that is secured, the distribution is taxable to the alternate payee. Moreover, in considering a QDRO to provide for a security interest, the parties must remember that the QDRO cannot contradict the provisions of § 414(p), which provides that the order cannot require the plan to provide any type or form of benefit, or any option, not otherwise provided under the plan.
Some plan administrators interpret § 414(p) to mean that when considering security interests in QDROs, he or she does not have to provide notice to either of the parties regarding the security interest.