Dividing your assets and debts in a divorce is mostly a matter to be dealt with at the state level, perhaps with the help of your lawyers or divorce mediator.
When it comes to retirement investments, however, reassignment must comply with the federal Employee Retirement Income Security Act (ERISA). What does this mean for you? If you’re planning on assigning your soon-to-be ex-spouse as an alternate payee (an individual other than the plan participant who is recognized as having a right to receive benefits) on any of your retirement plans (or vice versa), you’ll need to get a Qualified Domestic Relations Order (QDRO).
A domestic relations order is a decree that relates to the provision of child support, alimony payments or marital property rights for the benefit of an alternate payee (usually a spouse or ex-spouse). A QDRO is a specific type of domestic relations order that assigns an alternate payee the right to receive benefits under a retirement plan. In order for a domestic relations order to be a QDRO, it must be approved by the plan’s administrator.
Facts about QDROs
- When dividing a retirement plan using a QDRO, the plan participant and alternate payee are not subject to early withdrawal penalties unless they actually receive a distribution during the divorce. The plan participant will also avoid paying income tax on funds that are distributed to his or her ex-spouse. The ex-spouse essentially becomes a co-beneficiary to the existing plan and is responsible for any related taxes on his or her withdrawals.
- A QDRO can grant an alternate payee any amount of the retirement benefits, but it cannot require anything not provided in the original plan.
- QDROs can only mandate actions on retirement plans that are covered by ERISA. They don’t apply to military or government pensions, for example.
- Instead of merely splitting a retirement plan with your ex-spouse, you can choose to withdraw from it and use the funds to pay for child support or alimony. You can avoid the early withdrawal fee in this situation with a QDRO.
- Your spouse, former spouse, child or other dependent can all be named alternate payees in a QDRO.
No two QDROs are alike, as there are several options for dealing with the division of retirement benefits. If you or your spouse have multiple retirement accounts, you can even include several or all of them in one QDRO, assigning benefit rights for each plan individually. There are two main approaches for dividing retirement benefits:
- Shared Payment Approach: Each benefit payment is split between the plan participant and alternate payee according to the percentage designated in the QDRO. In this approach, the alternate payee does not receive a payment until and unless the participant receives a payment. This approach is usually taken when the plan participant is already receiving payments at the time of divorce.
- Separate Interest Approach: In this approach, the retirement benefit (not the individual payments) is split between both spouses, and they can choose to receive it differently. For instance, the plan participant can receive regular payments upon retirement as he or she normally would have, while the alternate payee receives benefits immediately. This approach is often taken when retirement benefits are used to offset other marital property divided between spouses.
Your QDRO can look much different depending on what kind of retirement benefits plan you are dividing. There are two main types of retirement accounts—defined contribution plans (such as your 401(k)) and defined benefit plans (pensions). The actual value of your benefit can vary depending on what type of plan you’re dividing:
- Defined Contribution Plans: Dividing a 401(k), IRA or similar account can be simpler than an employee pension. The value of the plan is the amount within the account at a given time, and it can easily be divided and paid to an alternate payee in one lump sum.
- Defined Benefit Plans: The value of a pension plan can fluctuate based on how many years the plan participant has worked, what his or her salary is, and any changes made to the benefits plan by the employer.
Requirements for QDROs
Once a QDRO is drafted, it must be approved by the plan administrator in order to be qualified. There are certain things that must be in a QDRO and others that will cause your proposed document to be rejected. To streamline the process, make sure your QDRO has the following:
- The name and last known mailing address of the participant, and each alternate payee
- The name of each plan to which the order applies
- The dollar amount or percentage (or the method of determining the amount or percentage) of the benefit to be paid to the alternate payee
- The number of payments or time period to which the order applies.
Make sure to leave these things out of your QDRO:
- The order must not require a plan to provide an alternate payee or participant with any type or form of benefit, or any option, not otherwise provided under the plan.
- The order must not require a plan to provide for increased benefits (determined on the basis of actuarial value).
- The order must not require a plan to pay benefits to an alternate payee if they are already assigned to a different alternate payee under a previous QDRO.
- The order must not require a plan to pay benefits to an alternate payee in the form of a qualified joint and survivor annuity for the lives of the alternate payee and his or her subsequent spouse.
From start to finish, getting a QDRO in place can take a long time and a lot of money, especially if it is rejected and needs several rounds of edits. The general timeline for creating and implementing a QDRO is as follows:
- During the divorce process, the divorcing couple decides to split retirement plan assets.
- Plan documents are requested from the plan administrator. You may also receive a sample QDRO from your administrator to use when drafting your own.
- The document is drafted, signed and filed with the court.
- The signed QDRO is sent to the plan administrator for approval.
- The plan administrator must promptly notify both parties of receipt and provide them with the plan’s procedures for the approval process.
- The plan administrator approves the QDRO and notifies both parties in writing promptly following a determination. If the order is rejected, the notice should include the reasons for the rejection.
- Once a QDRO is approved, assets are divided accordingly.
Avoid These Common Mistakes
Failing to create a QDRO in the first place is a common mistake, and divorcing couples should be aware that their divorce decree is not enough to adequately divide retirement assets. Here are some other common mistakes:
- Using the sample QDRO provided by your plan administrator. Since every divorce and retirement plan is different, every QDRO should be unique as well. The samples provided by your plan administrator are helpful in determining what is expected to be included in your QDRO, but don’t use it as a template. It may be helpful to have an attorney who specializes in QDROs draft yours.
- Waiting too long to draft your QDRO. If you retire or die before the draft is sent to your administrator, your spouse could lose any claim to the benefit. If you retire before the QDRO is entered by the court, your ex-spouse will have no choice in how to receive his or her payment. And if your ex-spouse dies before the QDRO is approved, it’s possible that his or her estate will receive no benefits.
- Not accounting for tax withholding. The alternate payee can choose to roll over funds to an IRA upon receipt. However, if he or she chooses to take a distribution, it will be taxed. If the alternate payee needs immediate access to funds from a retirement account, he or she must make sure to take out enough to account for the 20 percent tax withholding.
A QDRO is a complex but essential piece of your divorce proceedings. To ensure that both spouses receive assets they are due, you must make sure your domestic relations order is qualified by your plan administrator. Divorcing couples can benefit greatly from the help of a divorce attorney or financial advisor who specializes in QDROs and the division of retirement assets.