Basic Issues of Retirement Plans & Divorce

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Basic Issues of Retirement Plans & Divorce

A. Types of Plans

Retirement plans are divided in to two categories: Defined Benefit Plans and Defined Contribution Plans.

1. Defined Benefit Plans are plans where the amount of the ultimate benefit received by the employee is determined by a formula in the retirement plan. Usually, the benefit to be received is dependent upon a number of factors such as: years of credited service, age of retirement and highest salary. Although some governmental plans require employee contributions, most private plans do not.

2. Defined Contribution Plans.

The ultimate benefit that the employee will receive is a function of the amount contributed for the employee's account, plus growth in the account. The contributions may be made solely by the employee, as in an individual retirement account (IRA) or Keogh Plan; solely by the employer, as in a profit sharing plan; or by both, as in many tax deferred annuities and 401(k) plans, where a portion of the employee's contributions are matched by the employer.

a. Stated Value.

These plans are comparable to a savings account and the services of an actuary are generally not required to value them.

b. Tax Effect Not Immediate and Specific.

The assets contained in these plans generally will not have been taxed and therefore the recipient spouse should realize that there will be tax due upon receipt. Unless the employee is about to retire, the amount of this tax will usually not be considered by the courts in determining the value of the community interest in the plan, as the tax is not "immediate and specific."

c. Roll Them Over.

Usually these plans may be divided by dividing them into two portions, one for the employee and one for the spouse using a QDRO. The spouse will usually be able to take her share and roll them over into a rollover IRA in her name alone without immediate tax consequences. There is no need to prepare a QDRO for IRAs, they can be rolled over into the other party's rollover IRA. The financial institution has a form for this transaction.

B. Dividing Retirement Benefits

There have generally been three ways in which pension benefits have been divided over the years:

1. Reservation of Jurisdiction.

Under this method, the trial court simply defers the issue of the division of the pension plan to another date, usually after the employee retires, or is eligible to retire. At that later time, the court will make an order determining the nonemployee spouse's share in the retirement benefits, usually based on the time rule. This is no longer an approved way to handle pensions. Now they are either awarded to one party, divided at the time of trial or settlement, or the benefits are paid to the parties at retirement according to the time rule.

2. Inkind Division.

In this method, also referred to as the "time rule" or "formula approach," the court defines a formula for the future apportionment of the retirement benefits, as and when received. This formula determines the portion of the retirement benefits earned during the marriage and before separation and awards the nonparticipant spouse a sharegenerally onehalf. Usually the time rule is used, unless the benefits are unrelated to the time served, in which case some other approach which fairly allocates the benefits between the separate and community property efforts used to earn them may be used.

3. "Cashout" or Actuarial Present Value.

Under this approach, the court assigns the entire pension to the employed spouse and awards other community assets equal in value to the community interest in the retirement benefits to the nonparticipant spouse.

C. Valuation Strategies

1. Variables in Arriving at a Present Value.

a. Use of actuarial tables and discounts for ill health of party. In re Marriage of Bergman, supra.

b. Variations in the Use of Interest Rate based on the current prime rate and other variables. Bergman, supra.

c. Taxation of Proceeds not Considered.

D. Qualified Domestic Relations Orders

A Qualified Domestic Relations Order (QDRO) is used to accomplish "in kind" division of Defined Benefit Plans.

1. Exception to Rule Against Non-Assignment.

29 U.S.C. 1056 states "... [nonassignment and alienation provisions] shall not apply if the order is determined to be qualified domestic relations order. Each pension plan shall provide for the payment of benefits in accordance with the applicable requirements of any qualified domestic relations order."

2. Definition and Rules.

Qualified Domestic Relations Order (QDRO) is defined in 29 U.S.C. 1056 as follows:

Each pension plan shall provide for the payment of benefits in accordance with ... any qualified domestic relations order. (B) For purposes of this paragraph

(i) the term "qualified domestic relations order" means a domestic relations order

(I) which creates or recognizes the existence of an alternate payee's right to ... receive all or a portion of the benefits payable with respect to a participant under a plan ...

(ii) ... (I) relates to the provision of child support, alimony payments, or marital property rights to a spouse, former spouse, child or other dependent of a participant, and

(II) is made pursuant to a State domestic relations law (including a community property law).

(C) A domestic relations order meets the requirements of this subparagraph only if such order clearly specifies

(i) the name and the last known mailing address (if any) of the participant and the name and mailing address of each alternate payee covered by the order,

(ii) the amount or percentage of the participant's benefits to be paid by the plan to each such alternate payee, or the manner in which such amount or percentage is to be determined,

(iii) the number of payments or period to which such order applies, and

(iv) each plan to which such order

applies.

E. Problem Areas of QDRO

1. Jurisdiction over Plans.

State and federal courts have concurrent jurisdiction to review administrator's determination that order is not a QDRO.

2. Participants Account May Not Be Charged.

ERISA plan may not charge participant's account for reasonable administrative expenses incurred in qualifying QDROs..

3. Plan Rules Must be Followed.

The QDRO must comply with the Plan rules, so the Plan Administrator must approve the QDRO. The Plan rules must not violate ERISA. The alternate payee must make an application for a distribution i f required by the Plan rules.

4. Fees and Sanctions Not Available Against Plan.

Pursuant to 29 USC §Ý1132, attorney's may be awarded against the plan which must be joined. In re Marriage of Olivarez (1986) 188 Cal.App.3d 336 holds that the plan may deduct the fees from the employee's account. This result seems absurd and should only be permitted when the plan is acting on behalf of the employee. Smith v. CMTAIAM Pension Trust (9th Cir. 1984) 746 F.2d 587 allows fees if the litigant succeeds on any significant issue. It is not clear how to reconcile this case with Olivarez, supra. Does it mean that it would be better to sue the plan in Federal Court where you would be entitled to fees? In re Marriage of Shelstead (1996) 50 Adv.Cal.App.4th 1579 also discusses the issue of who is responsible and the factors involved in awarding fees . That case was granted review by the Supreme Court on February 26, 1997.

5. Follow the Rules.

a. TSA is not a Rollover IRA.

Blatt v. Commissioner (1993) 66 TCM 1409 - Husband's dissolution judgment provided that a QDRO would be drafted to transfer $194,304 from his Tax Sheltered Account (TSA) with TIAA-CREF into Wife's pre-exiting TSA. The tax court found that because Wife did not transfer the funds into a rollover IRA or an annuity she did not meet the requirements for a qualified transaction and she was taxed.

b. Rollover Must be Accomplished Within 60 days.

Spouse who did not roll over QDRO-based distribution of stock into IRA within 60 days must include distribution and dividends in gross income.

F. Tax Ramifications of QDRO

1. Tax and Penalty Free to Alternate Payee.

The general purpose of the QDRO is to transfer funds from the retirement plan of one spouse to the other spouse without incurring a penalty or a tax.

2. Cash Distribution Allowed.

Funds will either be rolled over into the spouse's rollover IRA or distributed as cash to the spouse. When the money is distributed as cash, it is taxed to the receiving spouse, but there is no penalty if done properly. When cash is distributed, the plan must withhold 20% for Federal Taxes.