Retirement plans are often one of the most valuable assets a couple acquires during a marriage. If a couple divorces and there is an agreement or judgment that requires all or a portion of the employee spouse’s retirement plan to be shared with the spouse or former spouse, the division is accomplished through a Qualified Domestic Relations Order (QDRO). The spouse or former spouse of the employee is often called an “alternate payee” for purposes of the QDRO. While state law governs the division of most marital assets, most employment related retirement plans are governed by the Employee Retirement Income Security Act of 1974 (ERISA) and the Internal Revenue Code (Code). In general, ERISA and the Code prohibit a retirement plan participant from assigning a portion of his or her interest in the plan to another person.
A QDRO is a limited exception to the anti-assignment of retirement benefits under ERISA and the Code. A QDRO assigns some or all of a plan participant’s retirement benefits to a spouse, former spouse, child, or other dependent to satisfy marital property rights, alimony, or child support obligations. Because a Plan will not assign benefits to anyone other than a plan participant, without a QDRO, the only method for the spouse or former spouse to collect a portion of the retirement plan is through a direct payment.
While the participant is often reluctant to part ways with a portion of his or her retirement plan, a QDRO is almost always the most favorable method of handling the assignment of a portion of a retirement benefit. Without a QDRO, if the participant spouse were to try to access funds from his or her retirement benefit to pay directly to a spouse or former spouse, the participant could potentially be restricted from doing so until satisfying certain conditions required by the Plan. Even if the employee spouse could access funds from a retirement benefit, by doing so the employee spouse would be paying taxes on the distribution from the retirement benefit and could potentially face a 10% penalty if one of the exceptions to the early withdrawal penalty does not apply. Under a QDRO, the alternate payee, not the employee spouse, is taxed on any distribution for purposes of satisfaction of marital property rights1. For a distribution from a defined contribution plan like a 401(k) or 403(b), the spouse or former spouse will not incur the early withdrawal penalty when the distribution is through the QDRO.
The parties to the divorce should be cognizant that the retirement plan still controls when and how the retirement benefit can be paid. For example, a defined benefit plan for a private company or union typically will require the employee spouse to attain a certain age or have a certain amount of service before a benefit can be paid. The plan can require that those same conditions apply to the alternate payee. In that case, if a QDRO is written to allow an immediate payment to the alternate payee, the retirement plan can deem the order not to be a QDRO and refuse payment until the QDRO aligns with its requirements.
While often the divorcing couple agree that a retirement plan is subject to division for equitable distribution purposes, the terms of the division are sometimes not specified. Usually, a QDRO must contain certain provisions, and if those provisions are not included, a retirement plan will treat those provisions in a certain manner by default. For the parties to maximize the control they can exercise over the retirement benefits, it is important to understand the type of retirement plan subject to division and when and how funds from the particular plan can be obtained.
If you need more information about dividing retirement plans in divorce, please contact us.
Article contributed by Allison Fried
1 Note that the participant is taxed on a distribution made for child support when the alternate payee is the child.