Avoiding Traps in QDROs

Before 1985, there was no way to attach the assets in a qualified pension plan for a spouse in a divorce proceeding. While a state court may have awarded a portion of the benefit, a plan administrator could not comply based on the federal laws governing pension plans (there were some exceptions for benefits already in pay status). The Retirement Equity Act of 1984 altered that by adding to the Internal Revenue Code ' 414(p), which allows qualified pension plans to divide plan assets if ordered through a properly drafted Qualified Domestic Relations Order (QDRO). The rules surrounding QDROs are complex; guidelines now abound, including guidance from both the IRS and the Pension Benefit Guarantee Corporation. What follows are some tips to assist drafters in avoiding common traps in these subtle
documents.

Can We Circumvent the Process?

Most family law attorneys understand the relevance of a QDRO when attaching pension assets through a divorce. However, occasionally, if the fact
pattern cooperates, there may be a way to circumvent the entire QDRO process (IRC ' 408(d)(6) in lieu of a QDRO). Many divorces involve several assets, ie, pension plans, a residence, taxable assets and IRAs. As the goal of a divorce is to apportion the existing assets in some sort of equitable manner, offsets are used. The pension is awarded to one, while the residence is awarded to the other; the taxable assets are given to the plaintiff, while the stock options are awarded to the defendant ' or some combination thereof ' is decided on. Because the IRAs are also sometimes split, along with the pension, it's worth addressing the simplest way to effectuate these final divisions.

Let's assume the court decides to split the two pension plans so, in essence, the wife will get the equivalent of $212,500. One way to effectuate this order is to have two QDROs prepared, assigning the alternate payee (spouse) the applicable shares of each qualified plan. However, there's an easier approach.
IRC ' 408(d)(6) states that 'the transfer of an individual's interest in an individual retirement account or an individual retirement annuity to his spouse or former spouse under a divorce or separation instrument described in subparagraph (A) of section 71(b)(2) is not to be considered a taxable transfer made by such individual.' This is a nice little bone thrown by Congress to divorcing parties. Pursuing the above example, instead of using two QDROs to equalize the pension funds, why not just transfer $212,500 from the husband's IRA to an IRA set up by the spouse for this purpose? No QDRO or special paperwork is necessary. You're just using the IRC to assist in the maneuver. The end result is the same, and you've eliminated a costly, time-consuming chore for all parties.

The mechanics are straightforward. The directive is spelled out in the divorce decree as to the amount to be transferred to the spouse from the husband's IRA. Once the divorce is finalized, the former wife opens an IRA wherever she wants, and gives the ex-husband the data on the account (ie, account number, name and address of trustee, etc.). The husband directs his IRA trustee to transfer the applicable amount directly to the wife's new IRA via a letter of instruction. There is no tax consequence to the transfer.

The end result is the same as if the pension programs had been attached and the
relevant funds transferred through QDROs.

Note that the funds must be transferred directly to the receiving spouse's IRA. If they are distributed (ie, paid to the spouse or to the IRA owner) rather than transferred directly to an IRA, they would be taxable, even if the receiving spouse rolled them over to an IRA. A few cites in this area include Harris v. Commissioner, TC Memo 1991-375 and Private Letter Rulings 94-22-060, 93-44-027 and 80-40-101.

While a seemingly simplistic approach, it can be a powerful tool in getting the divorce resolved faster, cleaner and with less of a hassle. It is something to keep in mind when the facts permit, ie, when there are sufficient IRA assets between the parties to offset any qualified pension awards.

What Happens if a Participant Dies?

Death is an unavoidable part of life. Should a participant's death occur between the time of a divorce and the date a QDRO is prepared, submitted to and approved by the plan administrator, the ex-spouse would get nothing ' zero. A plan administrator has no obligation to pay out anything based on a divorce decree. The only document a plan administrator can use to pay an alternate payee benefits from a qualified plan is a QDRO. Once a participant has died, the death benefit provisions of the pension plan document are triggered, along with any beneficiary designations the participant had completed prior to death and any QDROs accepted (by the plan sponsor) as of the date of death. If the ex-spouse is not part of these provisions, tough luck. IRC ' 414(p)(5) makes it clear that a former spouse can be treated as a surviving spouse for death benefits only if so noted in a QDRO.

Ideally, a QDRO should be prepared before a divorce is finalized, submitted at the same time the decree becomes official, and approved shortly thereafter, allowing a minimum of time between the divorce date and the date at which the QDRO becomes effective (based on this author's experience, this protocol is followed by only the most sophisticated family law attorneys). What can an attorney do to protect himself or herself between the time the divorce is finalized and the date the QDRO takes effect?

While not foolproof, the attorney for the non-participant spouse (termed the 'alternate payee' in QDRO language) could, at the time of the divorce, alert the plan administrator, in writing, that a divorce has awarded a certain amount of plan assets to a participant's ex-spouse. The communication should note the amount of funds involved and that a QDRO is pending, and could enclose a copy of the divorce decree. It would be appropriate to request acknowledgment of this correspondence, either through certified mail, return receipt or directly from the plan administrator.
While I am unaware of case law testing the legally binding nature of such a directive associated with the death of a participant prior to the QDRO being finalized, it should mitigate the chances of a successful malpractice case against the attorney(s) involved, should death occur prior to the ex-spouse receiving his or her expected payout. Without such an effort to bridge the gap between the divorce date and the approved QDRO, in the event of a participant's death, a successful malpractice case is more likely.

Additional Thoughts on Death Benefits

Many QDROs are prepared and finalized with little consideration given to the death of a participant, particularly prior to commencement of the payout. What happens if a divorced participant dies prior to an ex-spouse being paid out, after a QDRO has been accepted, and there is no provision in the QDRO for death benefits? You guessed it: The ex gets nothing. Even if the divorce decree stipulates specific instructions as to death benefits from the qualified plans, unless those instructions are relayed to the plan sponsor in the way of a QDRO, the intent of the parties will not be honored. In fact, the plan sponsor could be liable for a breach of fiduciary duties if it honors any form of attaching plan assets other than through a QDRO.
All varieties of pension and profit-sharing plans (including 401(k) plans) have provisions for death benefits. The key is to make sure that the ex-spouse is mentioned and is awarded the proper share of death benefits stipulated in the divorce decree. Therefore, death-benefit protection should be an item of discussion during the trial or final negotiations, so all parties are clear on how this point will be covered in the QDRO. In a defined-contribution plan (eg, profit-sharing, 401(k)), it's relatively easy to state that the ex-spouse will be named as beneficiary for any death benefits. Things are a little more complicated with defined-benefit plans, as the death benefit is payable in the form of an annuity and generally is 50% of the amount that would have been payable had the participant retired the day prior to death.

The pension plan documents should be reviewed for death benefit provisions, and the QDRO must state that the alternate payee (ex-spouse) is to be awarded whatever death benefits to which the parties have agreed.
What about the situation where a QDRO isn't timely submitted and the participant dies? As noted previously, if no death benefits are currently in pay status, the situation is probably moot ' the ex-spouse is out of luck. However, if benefits are in pay status to a successor spouse (in cases of remarriage), it 'may' be possible to submit a belated QDRO and request the plan administrator to pay a portion of any death benefits in pay status to a former spouse, based on the provisions of a divorce decree. This is conjectural and may or may not prove effective. It's worth a try before resorting to litigation.

Responsibility for Drafting and Paying for the QDRO

Generally, the provisions for allocating qualified pension benefits are finalized in the decree, with instructions that a QDRO be prepared to enforce the judgment. However, often no specific language is noted as to who is responsible for drafting the QDRO or who is to pay for it. If no specific instructions are in the decree, it's the non-participant spouse's attorney who should follow through on the QDRO document. As for payment, because it's in the interest of the non-participant spouse to have the QDRO effectuated ASAP, he or she should pay any preparation fees so this important implementation step isn't delayed. Ideally, specific responsibility for preparation and payment should be noted in the decree, along with instructions that the QDRO be prepared ASAP.

The worst-case scenario, and unfortunately examples abound, is when a divorce is finalized awarding specific pension benefits to one party and, due to oversight, incompetence or confusion, there were never any QDRO(s) prepared. At some point, possibly years later, one of the parties becomes aware of the omission. Now all sorts of little gremlins surface, as the effort to go back and reconstruct the necessary data to draft the QDRO is considerably greater than if it had been done timely when the divorce occurred; also, along with the risk of error and proper completion is the possibility that the participant may die and leave the alternate payee with no recourse as to benefits due him or her, other than a possible malpractice case against a lax attorney.

Rectifying Erroneous QDROs: The Amendment Process

What happens when a QDRO has been improperly prepared, accepted and implemented? Is there recourse? Yes, QDROs can be amended, providing the errors are the type that can be adjusted through a qualified plan, eg, an increase in the monthly dollar amount. Prepare an 'amended' QDRO, and go through the generally accepted procedures for acceptance. On approval by the plan administrator of the corrected, properly executed document, the proper intent of the divorce decree will be implemented.

Before 1985, there was no way to attach the assets in a qualified pension plan for a spouse in a divorce proceeding. While a state court may have awarded a portion of the benefit, a plan administrator could not comply based on the federal laws governing pension plans (there were some exceptions for benefits already in pay status). The Retirement Equity Act of 1984 altered that by adding to the Internal Revenue Code ' 414(p), which allows qualified pension plans to divide plan assets if ordered through a properly drafted Qualified Domestic Relations Order (QDRO). The rules surrounding QDROs are complex; guidelines now abound, including guidance from both the IRS and the Pension Benefit Guarantee Corporation. What follows are some tips to assist drafters in avoiding common traps in these subtle
documents.

Can We Circumvent the Process?

Most family law attorneys understand the relevance of a QDRO when attaching pension assets through a divorce. However, occasionally, if the fact
pattern cooperates, there may be a way to circumvent the entire QDRO process (IRC ' 408(d)(6) in lieu of a QDRO). Many divorces involve several assets, ie, pension plans, a residence, taxable assets and IRAs. As the goal of a divorce is to apportion the existing assets in some sort of equitable manner, offsets are used. The pension is awarded to one, while the residence is awarded to the other; the taxable assets are given to the plaintiff, while the stock options are awarded to the defendant ' or some combination thereof ' is decided on. Because the IRAs are also sometimes split, along with the pension, it's worth addressing the simplest way to effectuate these final divisions.

Let's assume the court decides to split the two pension plans so, in essence, the wife will get the equivalent of $212,500. One way to effectuate this order is to have two QDROs prepared, assigning the alternate payee (spouse) the applicable shares of each qualified plan. However, there's an easier approach.
IRC ' 408(d)(6) states that 'the transfer of an individual's interest in an individual retirement account or an individual retirement annuity to his spouse or former spouse under a divorce or separation instrument described in subparagraph (A) of section 71(b)(2) is not to be considered a taxable transfer made by such individual.' This is a nice little bone thrown by Congress to divorcing parties. Pursuing the above example, instead of using two QDROs to equalize the pension funds, why not just transfer $212,500 from the husband's IRA to an IRA set up by the spouse for this purpose? No QDRO or special paperwork is necessary. You're just using the IRC to assist in the maneuver. The end result is the same, and you've eliminated a costly, time-consuming chore for all parties.

The mechanics are straightforward. The directive is spelled out in the divorce decree as to the amount to be transferred to the spouse from the husband's IRA. Once the divorce is finalized, the former wife opens an IRA wherever she wants, and gives the ex-husband the data on the account (ie, account number, name and address of trustee, etc.). The husband directs his IRA trustee to transfer the applicable amount directly to the wife's new IRA via a letter of instruction. There is no tax consequence to the transfer.

The end result is the same as if the pension programs had been attached and the
relevant funds transferred through QDROs.

Note that the funds must be transferred directly to the receiving spouse's IRA. If they are distributed (ie, paid to the spouse or to the IRA owner) rather than transferred directly to an IRA, they would be taxable, even if the receiving spouse rolled them over to an IRA. A few cites in this area include Harris v. Commissioner, TC Memo 1991-375 and Private Letter Rulings 94-22-060, 93-44-027 and 80-40-101.

While a seemingly simplistic approach, it can be a powerful tool in getting the divorce resolved faster, cleaner and with less of a hassle. It is something to keep in mind when the facts permit, ie, when there are sufficient IRA assets between the parties to offset any qualified pension awards.

What Happens if a Participant Dies?

Death is an unavoidable part of life. Should a participant's death occur between the time of a divorce and the date a QDRO is prepared, submitted to and approved by the plan administrator, the ex-spouse would get nothing ' zero. A plan administrator has no obligation to pay out anything based on a divorce decree. The only document a plan administrator can use to pay an alternate payee benefits from a qualified plan is a QDRO. Once a participant has died, the death benefit provisions of the pension plan document are triggered, along with any beneficiary designations the participant had completed prior to death and any QDROs accepted (by the plan sponsor) as of the date of death. If the ex-spouse is not part of these provisions, tough luck. IRC ' 414(p)(5) makes it clear that a former spouse can be treated as a surviving spouse for death benefits only if so noted in a QDRO.

Ideally, a QDRO should be prepared before a divorce is finalized, submitted at the same time the decree becomes official, and approved shortly thereafter, allowing a minimum of time between the divorce date and the date at which the QDRO becomes effective (based on this author's experience, this protocol is followed by only the most sophisticated family law attorneys). What can an attorney do to protect himself or herself between the time the divorce is finalized and the date the QDRO takes effect?

While not foolproof, the attorney for the non-participant spouse (termed the 'alternate payee' in QDRO language) could, at the time of the divorce, alert the plan administrator, in writing, that a divorce has awarded a certain amount of plan assets to a participant's ex-spouse. The communication should note the amount of funds involved and that a QDRO is pending, and could enclose a copy of the divorce decree. It would be appropriate to request acknowledgment of this correspondence, either through certified mail, return receipt or directly from the plan administrator.
While I am unaware of case law testing the legally binding nature of such a directive associated with the death of a participant prior to the QDRO being finalized, it should mitigate the chances of a successful malpractice case against the attorney(s) involved, should death occur prior to the ex-spouse receiving his or her expected payout. Without such an effort to bridge the gap between the divorce date and the approved QDRO, in the event of a participant's death, a successful malpractice case is more likely.

Additional Thoughts on Death Benefits

Many QDROs are prepared and finalized with little consideration given to the death of a participant, particularly prior to commencement of the payout. What happens if a divorced participant dies prior to an ex-spouse being paid out, after a QDRO has been accepted, and there is no provision in the QDRO for death benefits? You guessed it: The ex gets nothing. Even if the divorce decree stipulates specific instructions as to death benefits from the qualified plans, unless those instructions are relayed to the plan sponsor in the way of a QDRO, the intent of the parties will not be honored. In fact, the plan sponsor could be liable for a breach of fiduciary duties if it honors any form of attaching plan assets other than through a QDRO.
All varieties of pension and profit-sharing plans (including 401(k) plans) have provisions for death benefits. The key is to make sure that the ex-spouse is mentioned and is awarded the proper share of death benefits stipulated in the divorce decree. Therefore, death-benefit protection should be an item of discussion during the trial or final negotiations, so all parties are clear on how this point will be covered in the QDRO. In a defined-contribution plan (eg, profit-sharing, 401(k)), it's relatively easy to state that the ex-spouse will be named as beneficiary for any death benefits. Things are a little more complicated with defined-benefit plans, as the death benefit is payable in the form of an annuity and generally is 50% of the amount that would have been payable had the participant retired the day prior to death.

The pension plan documents should be reviewed for death benefit provisions, and the QDRO must state that the alternate payee (ex-spouse) is to be awarded whatever death benefits to which the parties have agreed.
What about the situation where a QDRO isn't timely submitted and the participant dies? As noted previously, if no death benefits are currently in pay status, the situation is probably moot ' the ex-spouse is out of luck. However, if benefits are in pay status to a successor spouse (in cases of remarriage), it 'may' be possible to submit a belated QDRO and request the plan administrator to pay a portion of any death benefits in pay status to a former spouse, based on the provisions of a divorce decree. This is conjectural and may or may not prove effective. It's worth a try before resorting to litigation.

Responsibility for Drafting and Paying for the QDRO

Generally, the provisions for allocating qualified pension benefits are finalized in the decree, with instructions that a QDRO be prepared to enforce the judgment. However, often no specific language is noted as to who is responsible for drafting the QDRO or who is to pay for it. If no specific instructions are in the decree, it's the non-participant spouse's attorney who should follow through on the QDRO document. As for payment, because it's in the interest of the non-participant spouse to have the QDRO effectuated ASAP, he or she should pay any preparation fees so this important implementation step isn't delayed. Ideally, specific responsibility for preparation and payment should be noted in the decree, along with instructions that the QDRO be prepared ASAP.

The worst-case scenario, and unfortunately examples abound, is when a divorce is finalized awarding specific pension benefits to one party and, due to oversight, incompetence or confusion, there were never any QDRO(s) prepared. At some point, possibly years later, one of the parties becomes aware of the omission. Now all sorts of little gremlins surface, as the effort to go back and reconstruct the necessary data to draft the QDRO is considerably greater than if it had been done timely when the divorce occurred; also, along with the risk of error and proper completion is the possibility that the participant may die and leave the alternate payee with no recourse as to benefits due him or her, other than a possible malpractice case against a lax attorney.

Rectifying Erroneous QDROs: The Amendment Process

What happens when a QDRO has been improperly prepared, accepted and implemented? Is there recourse? Yes, QDROs can be amended, providing the errors are the type that can be adjusted through a qualified plan, eg, an increase in the monthly dollar amount. Prepare an 'amended' QDRO, and go through the generally accepted procedures for acceptance. On approval by the plan administrator of the corrected, properly executed document, the proper intent of the divorce decree will be implemented.