Thursday, February 07, 2013
What is a QDRO (pronounced “Quadro”)? A QDRO is a Qualified Domestic Relations Order, and is the document used to divide qualified retirement plans between spouses. If spouses wish to divide their pensions or retirement plans as part of their divorce, they will need a QDRO to separate the accounts. QDROs require care in drafting and an understanding of the legal and financial complexities of retirement plans. Unfortunately, poorly drafted QDROs often slip through the cracks, resulting in negative financial consequences.
While a QDRO is often one of the last items to be completed in a divorce, it can be the most important, especially if the retirement plans compromise a significant part of the marital estate. Make sure that you understand the process.
Here are some points to consider:
1. Know the type of plan. A defined benefit plan, simply put, pays a monthly amount at retirement. A defined contribution plan, simply put, allows the party to contribute tax free dollars into a retirement account to be withdrawn, usually in intervals, at retirement. QDROs for defined benefit plans differ from QDROs for defined contribution plans.
2. Because a QDRO is a court order and a legal document, the plan name must be correctly named. When companies are bought, sold and merged, the names of plans can change. The plan name in the QDRO must be the correct, complete legal name. Sometimes, parties or their lawyers confuse the name of the fiduciary trust company – such as “Vanguard” – with the plan name. If the participant spouse (the spouse who owns the plan) has a 401(k) plan with Widget Company, but the money is held in accounts with Vanguard then the correct plan name would most likely be Widget 401(k) Plan NOT Vanguard 401(k) Plan. Check your plan name with the plan administrator before drafting your QDRO.
3. What happens if the plan gains or loses money? You may have $100,000.00 in your retirement plan as of the date of separation, but the market could crash and your balance could drop to only $75,000.00 as of the date the QDRO is put into effect. How do we account for the changes in value and make sure both spouses take part in the risks and rewards associated with the plan? The QDRO must address the provision for increases and/or decreases in the amount of money going to the alternate payee (the spouse who is receiving a portion of the plan). If the alternate payee automatically shares in gains and losses, then both parties benefit from market increases and share in the risks of a volatile market.
4. Picking a valuation date. Check with the plan before choosing a valuation date because some plans only use specific dates, such as the end of the month or the end of the quarter.
5. Who are the named beneficiaries? What if the alternate payee dies before he or she receives their distribution? Some plans require that the QDRO name additional alternate payees or include language that provides that the funds are paid to the estate of the alternate payee. Know what the plan permits and draft your QDRO to account for unexpected deaths.
6. Combining a percentage and a dollar amount. When the drafter of a QDRO uses ambiguous language, chaos ensues. For example, if the QDRO states that the alternate payee receives 50% of the account balance less $15,000.00, different lawyers could interpret this provision different ways. Does the $15,000.00 gets subtracted first, then 50% set aside, or, do we set aside 50% taken, then $15,000.00 gets subtracted? Be precise in the language and realize that your document must stand on its own and allow only one interpretation.
7. What benefits are available? Make sure you understand the benefit options available under the plan. Some plans will not allow the alternate payee to choose to have the benefit paid for the lifetime of the alternate payee instead of the lifetime of the participant, and making that choice in the QDRO will cause rejection by the plan administrator. Understand what the plan provides and draft accordingly.
8. When do payments begin? Understand when the terms of the plans will allow payments to begin. In a defined contribution plan, if the plan prohibits it, an alternate payee cannot request an immediate distribution of funds. In a defined benefit plan, an alternate payee cannot request a time for the plan to begin paying benefits that contradicts the plan policy. Be specific when requesting a starting date for benefit payments and make sure the starting date conforms to the rules of the plan. The QDRO should allow the alternate payee the option of choosing when payments begin, but only as allowed by the plan, usually at a designated retirement age or another designated date.
9. Form of payment. Designating a form of payment that is not consistent with plan guidelines will ensure a rejection by the plan administrator. Many parties mistakenly assume that a traditional defined benefit plan will allow a lump sum distribution, but, realistically speaking, most will not offer that form of payment. Make sure you understand how the benefits will be paid.