Author: Elizabeth Van Clief

Elizabeth Van Clief works in the areas of Employee Benefits, Qualified Domestic Relations Orders (QDROs), Taxation, Business Planning, and ERISA Litigation.
401k Withdrawal

Sample MSA Language When There is a Retirement Plan Loan from Marriage

 

How Do You Handle A Retirement Plan Loan in a Marital Settlement?

Retirement plan loans are one of the most complicated aspect of QDROs to understand and handle correctly. A retirement plan loan is not actually “debt” as most attorneys understand that term. Instead, retirement plan loans can be thought of as a distribution, and generally should not be equalized with other types of debt (like credit card debt) in a family law divorce case. Here’s why.

When a participant from a retirement plan applies for a loan, the participant’s investments are sold in order to pay out the loan proceeds to the participant. Conversely, when the participant repays the loan balance, the participant retains their own loan payments and interest. Thus, in general, the account balance of a retirement plan already reflects a reduction for the loan.

It’s Important to Ensure One Party Is Not Hit Twice Financially

This can be a complicated analysis and not every plan is the same, but it is important to remember if there is a retirement plan loan, special attention should be given to make sure that one party is not hit twice with the financial aspect of the loan. Below is some common Marital Settlement Agreement language that may be helpful with regard to handling a retirement plan loan (see bolded sentence).

The parties agree that there is a community property interest in Husband’s [PLAN NAME]. The community property interest shall be determined by taking the account balance as of the Date of Separation, plus any contributions made after the Date of Separation that were earned during marriage, and adjusting that balance by investment earnings or losses in the Plan assets from the Date of Separation until the final date of distribution to Wife. Wife shall receive a 50 percent (50%) assignment of the community property interest using a Qualified Domestic Relations Order (“QDRO”). Any loans taken out during the marriage shall reduce the community property interest. The parties agree to jointly retain [QDRO ATTORNEY NAME] to be the neutral attorney to prepare the QDRO. The parties shall each pay half of [QDRO ATTORNEY NAME] fees and agree to cooperate with the QDRO process including providing all documents and information necessary for the preparation of the QDRO.

As always, different language may be appropriate on a case by case basis if there are unique facts.

IRAs and Divorce

Why a QDRO is not needed to divide an IRA

Contrary to popular belief, a Qualified Domestic Relations Order (“QDRO”) is not necessary to divide every type of retirement benefit. The prime example is an Individual Retirement Account (“IRA”).

An IRA is not a qualified retirement plan under the Internal Revenue Code and an IRA is not regulated by the Employee Retirement Income Security Act (“ERISA”). Therefore, ERISA regulations and Internal Revenue Code section 72(t) which otherwise govern QDROs do not pertain to IRAs.

If a financial institution representative informs you that a “court order” or “QDRO” is required to divide an IRA, then simply provide them with a copy of the Judgment / MSA because there is no such thing as a QDRO for an IRA.

A More Simplified Process

The good news for family law attorneys and divorcing spouses is that the process is more simplified and the attorneys’ fees involved are normally less than the cost of having a QDRO prepared. However, there are two aspects unique to IRAs that should be kept in mind when dividing IRAs pursuant to divorce.

1. Early withdrawal penalties apply.

Unlike the transfer of plan benefits with a QDRO, there is no exception in the Internal Revenue Code that permits a spouse to avoid the early withdrawal penalty of 10% federally and 2.5% California when receiving a distribution of IRA benefits prior to reaching age 59½. In other words, if an IRA holder desires to cash out their benefits prior to reaching age 59 ½, there will be a 12.5% penalty and the distribution amount will be taxed at ordinary income tax rates.

For clarity, it should be noted that if the IRA benefits are merely being “rolled over” in a “trustee-to-trustee transfer” from one spouse’s IRA to the other spouse’s IRA, then there is no tax consequence on that transfer and the benefits are held in the receiving spouse’s IRA as pre-tax benefits.

In contrast, the Internal Revenue Code provides under section 79(t)(2)(C) that a QDRO qualified for an exception to the early withdrawal penalty. Therefore, if the parties are planning to take any distributions of retirement benefits prior to age 59½, it may be preferable to do an equalizing assignment with a QDRO rather than equalizing benefits with an IRA.

2. A tax statement is recommended.

A signed “letter of instruction” with tax language is still recommended when an IRA is divided. Although a QDRO is not necessary, it is still important to document the IRA transfer in the event that the IRS or Franchise Tax Board conducts and audit of the IRA transfer. The typical tax statement will contain something similar to the following:

IRA Holder is the former spouse of Recipient. Both IRA Holder and Recipient acknowledge that this assignment is incident to divorce within the meaning of Internal Revenue Code section 1041. This assignment is related to the cessation of the marriage because this assignment is required by the Marital Settlement Agreement entered into between the IRA Holder and the Recipient. After the transfer, the Recipient shall be solely responsible for all income taxes or other tax consequences, if any, associated with the subsequent distribution of the assets to Recipient.

For reference,  the above language is intended to comply with the Internal Revenue Code section that provides for the tax free transfer of IRAs between spouses pursuant to divorce which is section 408(d)(6). The meat of Internal Revenue Code section 408(d)(6) [PDF]  is as follows:

(6) Transfer of account incident to divorce

The transfer of an individual’s interest in an individual retirement account or an individual retirement annuity to his spouse or former spouse under a divorce or separation instrument described in subparagraph (A) of section 71(b)(2) is not to be considered a taxable transfer made by such individual notwithstanding any other provision of this subtitle, and such interest at the time of the transfer is to be treated as an individual retirement account of such spouse, and not of such individual. Thereafter such account or annuity for purposes of this subtitle is to be treated as maintained for the benefit of such spouse.

What is the end result? The division of an IRA does not require a QDRO; however, a tax statement should be accompanied by the IRA transfer to make sure that it will fall squarely within IRC section 408(d)(6) if the IRS or Franchise Tax Board conducts an audit.

Elderly Hands Holding Wedding Ring

SDCERS and the Disappearing Survivor Benefit

Do not assume that a Domestic Relations Order can award an SDCERS survivor benefit

Most people think of government benefits as “better” than the employee benefits received from private employers. However, there are traps for the unwary when dividing government retirement benefits in divorce. Government retirement benefits such as benefits earned with the City of San Diego, County of San Diego, and State of California are not governed by ERISA.

Therefore, the rules and regulations that pertain to government benefits are not necessarily consistent with ERISA, or consistent with common sense. The rules governing the division of government benefits are established by government code and the government’s interpretation of their own code – which can change from year to year.

San Diego City Employees’ Retirement System (SDCERS) is governed by a 13 member Board of Administration and it is possible for a new Board to make the decision to interpret the San Diego Municipal Code differently than its predecessor Board.

In 2008, the SDCERS Board passed Board Rule 5.20 which eliminates the ability of a former spouse to receive the 50 percent Surviving Spouse Continuance unless the employee retired and a Domestic Relations Order was served on SDCERS prior to September 19, 2008.

In other words, even if both parties agree to give the former spouse a survivor benefit, SDCERS will not permit a current Domestic Relations Order to award the 50 percent survivor benefit continuance to the non-employee former spouse. This benefit simply disappears.

Board Rule 5.20 subpart (e) states: “The Former Spouse of a Member is not eligible for a Surviving Spouse Continuance if the Member retired or entered DROP on or after September 19, 2008.”

Although the language of the Rule is relatively simple to read, it is nevertheless difficult to conceptualize because of the following fact pattern: the parties marry, Husband retired while married, Wife was eligible for the 50 percent Surviving Spouse Continuance while married, and then the parties divorce in 2009.

The mere fact that the parties divorce after September 19, 2008, eliminates all entitlement to the continuance benefit. Wife would have received 50 percent of the monthly benefit after Husband’s death if they had stayed married, but instead Wife will receive zero dollars upon Husband’s death.

The SDCERS Board Rule has in essence divested Wife of this benefit simply because the divorce occurred.

SDCERS’ Board Rule 5.20 is Inconsistent with Carmona

Many family law attorneys are familiar with the Ninth Circuit case Carmona v. Carmona which held that a QDRO entered after retirement cannot eliminate the surviving spouse benefit that was elected at retirement.

The Court explained: “Because the retirement of a plan participant ordinarily crates a vested interest in the surviving spouse at the time of the participant’s retirement, we conclude that a DRO issued after the participant’s retirement may not alter or assign the surviving spouse’s interest to a subsequent spouse.”

Carmona guarantees the benefits elected at retirement for the surviving spouse, which is in direct conflict with the Board Rule 5.20 which eliminates the Surviving Spouse Continuance upon divorce.

The only way to explain the difference in logic between these two results is the plan in Carmona was a private plan governed by ERISA while SDCERS is a government plan governed by Code and open to Board interpretation.

Suggestion When Parties Have SDCERS Benefits

This article addresses the availability of the SDCERS Surviving Spouse Continuance upon divorce. There may be other benefits available to the Former Spouse depending the facts of each case such as whether the employee elected an Optional Settlement rather than relying only on the Surviving Spouse Continuance and whether the employee is retired.

One suggestion to parties who have SDCERS benefits or to family law attorneys assisting clients with dividing SDCERS benefits in divorce, is to have the Domestic Relations Order for SDCERS prepared and approved by SDCERS before a Marital Settlement Agreement is signed or before trial on this issue.

Furthermore, because the act of retiring is trigger event that sets limitations on survivor benefits, another suggestion is to wait until after the Domestic Relations Order is served before the employee retires. If retirement must occur before the Domestic Relations Order is filed, both parties should consider coming to an agreement in writing as to what election should be made by the employee at retirement.

Retirement Benefits Feature

The Good and the Bad of Gillmore Elections

Counseling a client on whether to elect Gillmore rights can be complicated, but using a framework in the form of “pros and cons” can help simplify the issue.

In re Marriage of Gillmore is a 1981 California Supreme Court decision which provides an additional “right” to a nonemployee spouse that is otherwise thwarted by a retirement plan from receiving their community property retirement benefits immediately. (In re Marriage of Gillmore (1981) 29 Cal.3d 418.) The fact pattern in Gillmore is surprisingly common. Gillmore is applicable when: (1) an employee is eligible to retire and commence retirement benefits from a defined benefit plan, (2) the employee is choosing to not retire, and (3) the retirement plan is refusing to pay any benefits to the nonemployee spouse pursuant to a qualified domestic relations order (“QDRO”) until the employee actually retires.

In the above situation, Gillmore allows the nonemployee spouse to collect the retirement benefits directly from the employee.

Many family law attorneys have the mistaken belief that a successful Gillmore motion must be accompanied by proof of “ill will” on the part of the employee spouse by showing that the employee is intentionally not retiring for the purpose of preventing the nonemployee spouse from receiving any portion of the community retirement benefits. However, there is nothing in the Gillmore decision that discusses motivation or intent, rather, it is a mathematical determination.

The Court in Gillmore explained, “It is a ‘settled principle that one spouse cannot, but invoking a condition wholly within his control, defeat the community interest of the other spouse.’” (Gillmore, citing to (1978) 21 Cal.3d 779, 786.)

Therefore, if the employee is making the decision to not retire, then the employee should be required to pay the nonemployee spouse the amount of retirement benefits that the nonemployee spouse would have received under the QDRO if employee spouse had elected to commence benefits.

This payment is made directly from the employee spouse by check every month; the payment is not made from the retirement plan.

Tips for Counseling a Client

With this framework in mind, the following practice tips can assist with counseling a client whether to move the court for an order for the employee to make payments to nonemployee spouse under Gillmore.

  1. Review the Marital Settlement Agreement (“MSA”) and QDRO for any reference to Gillmore Sometimes the parties have anticipated this issue and the MSA or QDRO already contains a waiver of Gillmore rights, an award of Gillmore rights, or an expedited procedure for enforcing or determining the amount of Gillmore rights.
  2. Explore whether the employee spouse will stipulate to make payments under Gillmore which would allow the parties to avoid the cost of a motion on the issue.
  3. Perform a mathematical analysis of the trade-off for the nonemployee spouse if the non employee spouse elects Gillmore. Answer these questions:
    1. What is the monthly dollar amount of the Gillmore payments (apply the time rule to the amount of payments the employee would receive if they retired immediately)? If the nonemployee spouse commences payments until Gillmore immediately, their monthly benefit amount for life is frozen (with the exception of cost of living adjustments) which means nonemployee spouse would miss out on any salary increases or overall benefit increases as a result of additional years of service. This is the complexity of the Gillmore election: the nonemployee spouse will receive benefits immediately but that monthly benefit amount is less than what the nonemployee spouse would receive if the nonemployee spouse waits for the employee to actually retire.
    2. What is the monthly dollar amount that the nonemployee would receive if they waited until the employee actually retired and commenced benefits? As discussed above, compare this figure to what the Gillmore payment would be and consider that payments are starting earlier under Gillmore, but the monthly payment is likely less.
    3. Consider the effect of receiving Gillmore payments on the nonemployee spouse’s eligibility and the amount of spousal support. If the nonemployee spouse is receiving spousal support and then commences receiving Gillmore payments from the employee, is the employee going to then reduce spousal support so that the nonemployee spouse is not any better off when receiving the Gillmore payments and the lowered spousal support.
    4. Finally, consider the cost of filing the Gillmore motion when deciding whether to move for Gillmore In many circumstances, Gillmore rights are not automatically awarded in the Marital Settlement Agreement and thus the employee is not breaching the Judgment by requiring the nonemployee spouse to file a formal motion for the court to award Gillmore payments.

In re Marriage of Gillmore provides a powerful tool for allowing a nonemployee spouse to receive their fair share of retirement benefits upon the employee becoming eligible to retire, but the nonemployee spouse must consider the mathematical tradeoffs in order to make the best decision.

 

Retirement Benefits Feature

Your 401(k) Assets Are Not “Old” – Think Twice Before Rolling Them Over

Almost every bank has some sort of advertisement that refers to your 401(k) benefits as “old” and encourages you to rollover your investments into an IRA. Wells Fargo’s tag line reads: “Consolidate old retirement assets with guidance,” Fidelity publishes articles with the headline “What to do with your old 401(k),” and, Charles Schwab has a TV commercial that opens with “Is your old 401(k) just hanging around?”[1]

These banks are all attempting to send home the message that your “old” 401(k) needs to be rolled over into a “new” IRA in order to have better investment returns. The advertisements in particular are appealing to your sense that you no longer work for your employer, so why leave your assets in your “old” employer’s retirement account? They are also implying that somehow 401(k)s only have “old” investment types available and IRAs have all of the “new” and better investments. This is simply not the case – ERISA retirement plan investments are reviewed each year by fiduciaries and participants with self-directed accounts in ERISA retirement plans actually choose their own investments.

Be Aware of the Downsides of Rolling Over your 401(k)

Furthermore, participants in a 401(k) plan should be aware of the downsides of moving funds from a 401(k) plan to an IRA which can include:

  • Higher maintenance fees charged for an IRA rather than to stay in the ERISA retirement plan. Fees in an ERISA plan are regulated by the Department of Labor.
  • More limits on investment options offered by the bank hosting the IRA compared to the investment options that an ERISA plan can negotiate for on a large scale basis.
  • Less protection of assets from creditors or legal judgments.
  • Higher transaction fees charged in an IRA than in an ERISA retirement plan.
  • More restrictions on withdrawing your benefits. (If you retire from a company at age 55 or older, you may be able to obtain penalty-free access to your 401(k) account whereas IRAs generally have a 59 ½ age requirement before benefits can be obtained penalty-free.)[2]
  • Fees for investment advice may be charged by the bank whereas in an ERISA plan your prior employer’s contract may include providing participants with investment advice for no fee.
  • No ability to obtain a loan from an IRA whereas many ERISA plans permit participants to take loans.

Wells Fargo even has a long disclaimer regarding rollover IRAs, but it is in the fine print:

“When considering rolling over assets from an employer plan to an IRA, factors that should be considered and compared between the employer plan and the IRA include fees and expenses, services offered, investment options, when penalty free withdrawals are available, treatment of employer stock, when required minimum distribution may be required, protection of assets from creditors, and legal judgments. Investing and maintaining assets in an IRA with us will generally involve higher costs than the other options available.” (emphasis added) [3]

The conclusion is simple:

ERISA plans should take pride in the upsides to participants of staying invested in the plan, and participants should consider their individual needs in order to make the best decision.

[1] http://www.ispot.tv/ad/7wxM/charles-schwab-ira-offer, https://www.fidelity.com/viewpoints/retirement/401k-options
[2] http://www.irs.gov/taxtopics/tc558.html
[3] https://www.wellsfargo.com/investing/retirement/rollover/