Tag: QDRO News April 2016

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Procedure for enforcing a QDRO against a retirement plan if the QDRO is processed incorrectly

In the event that an Alternate Payee or Participant affected by a QDRO believes that the Plan Administrator has processed the QDRO incorrectly, the proper ERISA procedure should be followed to first object to the QDRO, make an official claim for benefits, and ultimately pursue federal litigation under ERISA.

A QDRO can be processed incorrectly in a variety of ways such as refusing to honor the QDROs provisions regarding the form of benefit, timing of benefit commencement, or calculation of the ultimate benefit amount. The federal district court has subject matter jurisdiction on over such lawsuits pursuant to ERISA.

Elderly Hands Holding Wedding Ring

Is a retirement plan loan considered community property?

QDRO NewWhen a participant takes a “loan” from their retirement plan, the plan liquidates investment assets in order to pay the participant cash from the plan. This means that when an account statement for a 401(k) plan states: asset balance $15,000, loan balance $5,000, there is actually still $15,000 worth of community property investments in the plan. It is worth noting that different banks report plan loans differently on statements, so the treatment of the loan should be double checked with the bank prior to arriving at a firm conclusion.

Arguably, a loan should not be thought of as a debt at all. Instead, it is way of cashing out pre-tax dollars from a retirement plan. The reason that a loan is not a debt is the subsequent loan payments made by the participant to repay the loan increase the participant’s plan balance. In other words, the participant is simply transferring funds from their checking account to their retirement plan. They are repaying themselves.

Despite the conclusion that a retirement plan loan is not truly a “debt,” there are special tax and transferability considerations to be taken into account. A participant loan is accompanied by a tax disadvantage for the participant who retains the plan because a participant repays the loan with after-tax dollars and then the participant is ultimately taxed on the benefits when they are withdrawn at retirement. Furthermore, a QDRO cannot assign a participant loan from the participant to an ex-spouse. Parties in mediation or preparing for trial may benefit from a brief analysis on how to equitably treat a retirement plan loan which can depend on the specific facts and circumstances.

The bottom line is that a retirement plan loan is unique and not generally treated as a community property debt obligation.

Retirement Benefits Feature

QDROs can be used for collecting spousal support and child support

The use of a Qualified Domestic Relations Order (“QDRO”) is an often overlooked tool for assisting family law attorneys and divorcing spouses with the collection of child support or spousal support.

A QDRO can be used against a defined benefit plan (which pays monthly benefits over a participant’s lifeme) to collect ongoing monthly child support or spousal support. The participant must be in pay status in order for the defined benefit plan to be able to pay the monthly amount.

In other words, if the participant is not yet rered, the benefits will likely not be payable from the Plan under a child support or spousal support QDRO. Certain exceptions apply.

A QDRO can be used for a defined contribution plan (which has a current account balance) for the collection of spousal support or child support in a lump sum, such as arrears.

The authority for this collection activity resides in ERISA which provides that a QDRO can alienate benefits of the participant if it relates to the provision of child support, alimony  payments, or marital property rights to a spouse, former spouse, child, or other dependent and is made pursuant to a state domestic relations law. (29 U.S.C. § 1056(d)(3) (B)(ii)(I) and (II)).

Finally, it is important to note that child support QDROs and spousal support QDROs are somewhat specialized with regard to the tax consequences. Child support payments from a retirement plan are taxed to the participant, not the alternate payee.

Dividing IRAs in Divorce: Why a QDRO is not necessary to assign IRA benefits to an ex‐spouse

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 your client should provide the financial institution with a copy of the Judgment and MSA which will suffice as the court order. A letter of instruction or other forms will sll be necessary, but as far as providing a court order, the Judgment and MSA will satisfy the requirement of a court order.

The good news for family law attorneys is that the process for dividing an IRA is more simplified than having a QDRO prepared. However, there are two aspects unique to IRAs that should be kept in mind:

  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% (federal) 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” using 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 secon 79(t)(2)(C) that a QDRO qualifies 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.

  1. 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 sll 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 secon 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 secon that provides for the tax free transfer of IRAs between spouses pursuant to divorce which is secon 408(d)(6). The meat of Internal Revenue Code secon 408(d)(6) 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 secon 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 accompany the IRA transfer documentation to document compliance with IRC secon 408(d)(6) if the IRS or Franchise Tax Board conducts an audit.

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.