QDRO Corner: Clever Work-Arounds for Common Plan Prohibitions

It’s a common situation, the parties finally reach an agreement after painstaking negotiations, and rather than have someone change their mind, the parties sign the agreement before checking the rules of the retirement plan. They then hire an attorney to draft the QDRO. The QDRO attorney then has to tell the parties that they’ve agreed to something the retirement plan cannot accommodate and they have to go back to the negotiation table with their divorce counsel. Speaking from experience, this is pretty bad news to have to tell parties.

Pension Plans and the Cost for Survivor Benefits.

Many pension plans, like FERS and CSRS for federal government civilian employees, allow for the cost of the survivor benefit to be shifted. Meaning, that the retirement order can state that one party or the other will fully bear the burden of any reduction incurred for the future survivor benefit. Other plans, such as the military retired pay, Maryland State Retirement and Pension System, and most international organization retirement systems, do not allow for such shifting and instead require that the reduction be taken “off the top” or before the benefit payment is divided between the parties.

 The common issue we see is that parties have agreed to shift the cost of the survivor benefit for a plan that does not accept that language in their retirement orders. For many agreements, this cost in particular is a large point of contention and is only awarded to the former spouse on the condition that the former spouse would pay that cost. So what now?

In cases where a reliable estimate can be obtained or prepared the best case is to simply change the phrasing. Instead of using a formula in the retirement order in which the plan has to fill in the information, do it based off of the estimate and reduce the former spouse’s share to a percent of the whole. To best protect each parties’ interests, include a clause that says once the participant begins to receive benefits the parties will revisit the calculation to ensure the proper amount is awarded to the former spouse. This way the retirement order is in place as of the divorce, and the former spouse is already receiving a reduced benefit to account for the survivor benefit from the start of the benefit payments. If the estimate done during the divorce is too different from the actual payments, the parties can have an amended retirement order prepared and submitted. 

If no reliable estimate can be prepared, the parties can still agree as they would, to the formula amount awarded to the former spouse, but that once the benefit payments begin, the former spouse will reimburse the participant on a regular schedule for the cost of the survivor benefit, upon proof being shown of the cost, until an amended QDRO can be effectuated.

Neither of these are as simple as having the plan shift the cost themselves, but they are good back-up solutions to an otherwise potentially deal-breaking situation.

Defined Contribution Accounts and Earnings, Gains, and Losses

Parties can agree that a transfer out of a 401k-type account include earnings, gains, and losses thereon from a certain date through the date of transfer. This allows the transfer amount to go up and down with the market investments of the account until they are transferred to the former spouse. Recently, some financial institutions have stopped allowing for this calculation, instead requiring that the transfer amount be described as occurring on the date of transfer.

This can result in wildly different outcomes. For example, imagine a transfer amount was $50,000 with earnings, gains, and losses as of the date of divorce and the transfer actually happens 6 months thereafter. During those 6 months, the market crashes and suddenly that $50,000 is equivalent to $20,000 after the earnings, gains, and losses are applied. The parties clearly intended that the former spouse should receive $20,000 in such a circumstance. If this plan prohibition was in place, however, then the former spouse would receive $50,000, and the participant would have a substantially smaller balance remaining in their account than the parties intended. So, what now?

If the account funding the transfer is no longer the person’s active retirement account, as in there are no contributions, withdrawals, or active investment scheme changes happening in the account the solution is to simply reduce the former spouse’s share to a percent and describe the transfer amount as the percent as of the date of transfer. From the example above, if the $50,000 with gains and losses the former spouse was supposed to receive would be 50% of the account, then after the market crashes and the entire account balance is $40,000, the former spouse would still receive 50% of the account, but it would be $20,000.

What if the account is receiving mandatory employer contributions? The parties may want to get a financial professional involved, but they could estimate where the account balance should be at the time, they anticipate the transfer to be made based off of expected employer contributions during that time. With the estimated contributions and market fluctuations thereon added, the parties could come up with a percent of the account for the former spouse’s share, with a continency to prepare an amended QDRO if something wild happens in the meantime.

Keeping with the same figures, if the former spouse should receive 50% or $50,000, that means the account has $100,000 at the time of the valuation. If the parties anticipate that the employer contributes $20,000, the former spouse should receive $50,000 or 41% of the account. Market changes will impact the transfer amount here, same as above. 

If you run into a similar situation and need help finding a creative solution contact us at 240-396-4373 and we can discuss your case and if we can help.