Dividing the Nest Egg in Divorce

Nothing is more heart-wrenching than to realize that your savings for retirement and your golden years will be fractured because of divorce. Just like all your other assets accumulated in marriage, your retirement plans may be "marital property," and thus subject to an equitable division in a divorce.

What is a retirement plan? Usually this means either a defined contribution plan [such as a 401(k) or 403(b) plan] or a defined benefit plan (a traditional fixed “pension” that a government employee might receive). More than 46 million workers are currently covered by employer-provided retirement plans in the United States, according to the U.S Department of Labor.¹ For most of them, these plans are a significant portion of their total assets. For this reason, whether and how to divide a participant's interest in a retirement plan are often important considerations in separation, divorce, and other domestic relations proceedings. 

Valuing and dividing retirement plans is not simple. Typically, you need a lawyer who specializes in this area. Retirement plans are complicated and have long-term consequences. Many family lawyers don't wish to test the strength of their malpractice coverage by dabbling in them. Some retirement plans may require an expert who can value them in present value dollars if a divorcing spouse prefers to offset the retirement plan with other assets.

According to the Labor Department’s The Division of Retirement Benefits Through Qualified Domestic Relations Orders:

Although most marital property divisions are governed by state law, the division of marital retirement plans also must comply with Federal law and is accomplished by a “QDRO” – a “Qualified Domestic Relations Order”. According to federal rules any assignments of retirement interests must comply with the Employee Retirement Income Security Act of 1974 (ERISA) and the Internal Revenue Code of 1986 (the Code). Under ERISA and the Code, retirement interests may be assigned only if the judgment, decree, or order creating or recognizing a spouse's, former spouse's, child's, or other dependent's interest in an individual's retirement benefits constitutes a "qualified domestic relations order" or "QDRO."

According to the Dept. of Labor (which regulates most retirement plans) a QDRO “may assign some or all of a participant's retirement benefits to a spouse, former spouse, child, or other dependent to satisfy family support or marital property obligations”.

Why have a QDRO at all? Well for one, without a QDRO, any retirement plan distributions to your ex-spouse would be treated as taxable income to you — and subject to early distribution penalties if you are under 59 ½.

According to the Labor Department’s The Division of Retirement Benefits Through Qualified Domestic Relations Orders:

With a QDRO, you[r] ex-spouse would ultimately be responsible for taxes on distributions if and only if the order is a "qualified domestic relations order." To the extent that a QDRO requires that your former spouse be treated as the your surviving spouse for all or any part of the survivor benefits payable after your death, be aware that any subsequent spouse of yours cannot be treated as your surviving spouse (in same plan) for receiving your retirement benefits.

A state authority, generally a court, must actually issue a judgment, order, or decree or otherwise formally approve a property settlement agreement before it can be a "domestic relations order" under ERISA. The mere fact that you and your ex-spouse agree to and sign a property settlement will not, however, cause the agreement to be a QDRO, but QDRO requirements are fairly simple. Determination as to whether it is “qualified” is not made by the issuing court but by the retirement plan administrator. Every ERISA plan must have “reasonable” QDRO procedures in place and plan administrators are required to follow them. After receiving a QDRO, they must provide notice of receipt to all parties, copies of their procedures, an accounting of plan funds and are responsible for the plan distributions required by the order. By law, retirement plans are neither permitted nor required to follow the terms of domestic relations orders purporting to assign retirement benefits unless they are QDROs.

During the time a QDRO is being determined (by a plan administrator, by a court of competent jurisdiction, or otherwise), ERISA requires that your plan administrator separately account for the amounts that would be payable to your ex-spouse (alternate payee) under the terms of the order. The plan administrator must take steps to ensure that amounts that would have been payable to your ex-spouse, if the order were a QDRO, are not distributed to you or any other person. The plan administrator's duty to separately account for and to preserve the segregated amounts is limited in time to 18 months from the time that a first payment under the order would be due.

Normally a draft QDRO is presented to the plan administrator for pre-approval; once this is obtained (which may take months), the QDRO is presented to the court along with the rest of the divorce decree, and then the court certified QDRO is given to the plan administrator for final approval. Generally, your ex-spouse is more at risk than you are in this process. 

For example, if you retire or die before the QDRO is served on your Plan Administrator, your ex-spouse could lose the entire benefit. If you retire before the QDRO is entered by the court, your ex-spouse will be stuck with whatever payment option you select at retirement. If your ex-spouse dies before the QDRO is accepted by the plan administrator, it is very possible that no benefits will be payable to his or her estate. 

Finally, if too much time passes, the plan may not be able to determine what the account balance was, or to be able to calculate earnings and losses as of date of divorce. Plans are changing administrators with greater frequency. New administrators do not have access to individual account balances or investment information prior to their taking over. You are responsible for making sure the QDRO is completed on a timely basis as well as for staying in touch with the plan administrator if you will receive a payout in the far future.

To ensure both peace of mind and the intended outcome of your divorce, start the QDRO preparation process before you finalize your divorce. Be sure you follow through to its conclusion, when you are assured it has been accepted and implemented by your plan administrator.

¹ www.dol.gov/ebsa/publications/qdros.html 

Additional Resources:

• What Common QDRO Mistakes Should You Avoid in Your Divorce?

FPA member Lili A. Vasileff, CFP^®, CDFA™ is the President of the Association of Divorce Financial Planners, the largest national not for profit organization of divorce financial planners and allied divorce professionals, and President of her own private practice called Divorce and Money Matters, LLC.