The Problem of the Missing QDRO

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Holder_RitaClients often consult with a family law attorney requesting modification or enforcement of some aspect of their dissolution judgment. They may ask for help with changes in spousal support, for a court order for sale of the family home after the kids leave, or enforcement of child support payments. No surprise there.

But what is surprising is the number of post-dissolution clients who have never had a Qualified Domestic Relations Order (QDRO) prepared on their behalf.

The amount of money left on the table after a divorce can be staggering. Routinely, clients are awarded $50,000 to $100,000 (or more) in retirement plan assets in the property settlement. But regrettably, many never claim a penny.

The client may not understand, for example, that a lifetime pension was theirs for the taking. Or they mistakenly assume that because the nest egg is identified in the judgment, a pension check will inevitably be sent to them when they reach age 65. So they wait, sometimes five, 10, even 20 years after the divorce, without ever having a QDRO drafted.

Usually the QDRO can be issued without incident. But a fateful few may be devastated to find that their long-forgotten former spouse has (unlawfully) taken and spent all the retirement assets awarded in the ancient judgment. Unfortunately, by the time the misappropriation is discovered, the wrongdoing spouse may be penniless or dead.

A Complex Area of Law

missing_puzzle_webHow does the problem of the pretermitted QDRO arise? To be honest, it is very complicated to draft a QDRO, have it approved by the retirement plan’s administrator and opposing counsel, get it signed by both the parties and the judge, and finally be able to get some money out of the plan.

The body of law relating to retirement plans is complex and byzantine. To further confuse the unwary practitioner, the US Tax Code (Internal Revenue Code of 1986, as amended, 26 U.S.C. §1 et seq. (Code)) and the Employee Retirement Income Security Act of 1974 (ERISA) are often duplicative of each other.[1] As a result of this duplication, there are two sets of virtually identical QDRO rules—one set in ERISA section 206(d)(3)(B)(i) and the other in Code section 414(p)(1)(A).

In addition to the Code and ERISA, there are at least 40 other acts that also affect retirement plans. If the employer violates any of these rules, they face the draconian threat of plan disqualification. If that happens, the employer and employee may be forced to pay ordinary income tax on the money in the plan accounts.

The Department of Labor’s (DOL) Employee Benefits Security Administration (EBSA) provides guidance on ERISA, generally, and QDROs, specifically. The DOL’s guidance materials can be found at http://www.
dol.gov/ebsa/publications/. Both the DOL and Treasury (i.e., IRS) regulations must be complied with for a QDRO to hold water.

Getting the Facts

Because the family’s biggest assets may be their employee benefit plans, family law attorneys must determine what these benefits are worth. This information cannot be overlooked! Given all of the above-mentioned complexity in the law, this can be a challenge. Attorneys may find that clients have little knowledge as to the type, or value, of the couple’s retirement plans. In some cases, the assistance of ERISA counsel may be advisable.

Most employers will provide general information about plan benefits, if asked by the spouse or the spouse’s attorney. If the client is uncertain as to their spouse’s retirement plan benefit, and is unable to obtain them from the employer, the attorney should identify them through the use of interrogatories, requests for production of documents, or subpoena duces tecum issued to the plan’s administrator.

In addition, remember to find out if the spouse maintains an Individual Retirement Account (IRA), so that it too may be included in the property settlement. Be sure to ask for account statements and recent pension estimates.

Retirement benefits will be either traditional “defined benefit” pension plans, funded entirely by the employer, or defined contribution plans, such as 401(k) plans, often funded by a combination of employee and employer contributions. Once you find out what kind of plan the client or the spouse participates in, the next task is to find out how much that employee benefit plan is worth in actual dollars.

In a surprising number of situations, the employee-spouse keeps, or gives up, their entire pension without the client or the attorney knowing exactly how much it was worth. Seek expert help if there is any question in this area.

In order to value the defined benefit plan assets, it is often advisable to engage the services of an actuarial firm on your client’s behalf. The actuary can be a matter for stipulation, or the court can be asked to make a decision as to the actuary to be engaged. An actuarial valuation can cost anywhere from $500 and up. However, this is money well spent, and can be split between the parties. Once the actuary values the retirement plan assets of the parties, informed negotiations can begin.

Preparing the QDRO Document

When the parties reach agreement on the community property division, the Marital Settlement Agreement (MSA) or Stipulated Judgment can be drafted, incorporating precise language that describes the manner in which the retirement plans are to be divided.

Attorneys are often understandably confused, believing that once the retirement plan assets are identified, discussed and divided in the judgment or the MSA, that should be the end of it. Unfortunately, this is not true. There is another essential step in the division of retirement benefits after the judgment or final decree is entered.

The next step is drafting the QDRO. First, contact the plan administrator to get a copy of the plan’s model QDRO, if available, and written QDRO procedures. If a model QDRO is not available, the attorney will need to draft the language of the QDRO on their own. The administrator of the plan is the arbiter of all things QDRO. In a defined benefit plan, the question of survivor benefits must be considered—for both the employee and the non-employee.

If the non-employee is awarded a portion of the employee’s account balance in a defined contribution plan, the non-employee’s spouse’s attorney will need to protect the spouse’s interest in case he or she dies before benefits are distributed. Any attorney who decides to prepare a QDRO without consulting the plan administrator does so at his or her own peril.

Next, even if the attorney is using the model QDRO format from the administrator, it is the best practice to prepare a draft for the administrator’s review and that of opposing counsel. Any problems identified by the plan administrator or counsel can be ironed out before the order is presented to the judge. The plan administrator can still reject the QDRO as not meeting employer requirements, even though the judge has already signed it!

Taxation of the Distribution

If the QDRO passes the muster of the plan administrator and is signed by the court, it is then sent back to the plan administrator. In due course, a distribution from the qualified retirement plan will be made to the non-employee spouse (the “alternate payee”) either in cash or a defined benefit stream of payments.

Invariably, the alternate payee will be disappointed to find that the distribution is subject to a 20 percent mandatory income tax withholding. To avoid this mandatory withholding, the alternate payee has 60 days to roll over the QDRO distribution as per Code sections 402(c), 402(e)(1)(B) and 3405. The 10 percent early distribution penalty does not apply to distributions made pursuant to a QDRO.[2]

The IRS’ “Special Tax Notice Regarding Plan Payments,” which will be sent to the alternate payee, is quite informative. It can be downloaded from the IRS’ website at www.irs.gov, or by calling 1-800-TAX-FORMS. Practitioners should note that even if the client receives bad tax or legal advice regarding a QDRO rollover, the transaction cannot be undone and will not qualify for deferred tax treatment.[3]

California has mandatory state income tax withholding of 10 percent of the federal income tax withheld—unless the taxpayer elects to opt out of withholding (CA Form DE4P). Like the Feds, there is no California state income tax withheld if the QDRO distribution is rolled directly into an IRA or another qualified plan. The 2½ percent state premature distribution penalty does not apply to distributions pursuant to divorce.

Many post-dissolution clients have never had a QDRO prepared on their behalf. This may be due to the fact that the body of law relating to retirement plan QDRO is full of twists and turns. Unlike case law, tax law does not hold much wiggle room. Practitioners should pay close attention to the Code and ERISA requirements when drafting a QDRO.


Rita A. Holder maintains a law practice in Walnut Creek, specializing in family law and ERISA. For over 30 years, she has advised many companies, large and small, about ERISA issues and QDRO procedures. Rita holds an LL.M. in Tax/ERISA. She can be reached at rita@ritaholderlaw.com.


[1] ERISA is found at 29 U.S.C. Ch. 18 et seq.
[2] Code § 72(t)(2)(C).
[3] Mills v. Commissioner, T.C. 2003-41.

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