employers have any desire to get caught in the middle of the divorce
proceedings of their employees; however, when company retirement benefits
become part of the negotiations, unsuspecting employers can be pulled into
One of the foundational rules for qualified retirement plans is that
participants’ benefits cannot be pledged as collateral or assigned to
another party. Conditioning the plan’s tax-favored status on this
prohibition helps to protect participant benefits; however, there are a
small number of exceptions to this rule.
One such exception is that benefits can be included in marital property
and assigned to a former spouse as part of domestic relations proceedings.
This is accomplished via a Qualified Domestic Relations Order or QDRO.
What is a QDRO?
As the name suggests, a QDRO is a court order issued pursuant to state
domestic relations laws (Domestic Relations Order or DRO) that is used to
assign company provided benefits to an alternate payee, typically as part of
divorce or marital separation proceedings. Although the rules governing
QDROs are relatively straightforward, many divorce attorneys tasked with
drafting them are unfamiliar with the nuances of qualified retirement plans.
That can make an otherwise simple situation very complicated very
quickly…and when dealing with the emotionally charged setting of a divorce,
complication can lead to unpleasantness.
There are several key elements that must be included in a domestic
relations order for it to be considered a QDRO.
Identification of the Parties
The order must identify the plan, participant and the alternate payee,
i.e., the party receiving benefits. This requirement is usually, but not
always, easily satisfied. For example, an order that identifies the plan as
the ABC Company’s retirement plan may be sufficient if ABC Company has only
sponsored a single retirement plan. However, if ABC has both a 401(k) plan
and a cash balance plan, the order would be too vague without specifically
naming the plan to which it referred.
Data privacy concerns have led many to discontinue including social
security numbers as a means of identifying the participant and alternate
payee, so there must be sufficient information included to ensure proper
identification of all parties. This may be an easy task in most cases, but
further detail may be needed if a participant’s name is John Smith.
Description of Benefits
The order must clearly articulate the amount of benefits to be paid or a
formula for determining the benefits. For example, an order may require a
participant to pay a former spouse $50,000. Alternatively, it may describe
the benefit as 50% of the vested account balance as of a specified date.
These two may be combined to ensure a minimum or maximum level of benefits,
e.g., 50% of the vested account balance as of January 1, 2011, subject to a
minimum amount of $50,000.
Then, there is the question of investment performance. If there is a lag
between the determination date (January 1, 2011 in the above example) and
the date the benefits are actually paid, the order should specify if the
alternate payee is to share in any investment gains or losses during the
Purpose and Direction of Payment
A QDRO must provide child support, alimony or other marital property
rights. Although the alternate payee is typically a spouse, former spouse,
child or other dependent, benefits can be payable to another entity for the
benefit of one of these parties. For example, the order may direct payment
to a state department of family services to provide benefits for a
Just as some items are required, other provisions will disqualify an
Inconsistency with Plan Provisions
An order is not permitted to provide a type or a form of benefit or a
benefit option the plan does not otherwise provide. For example, if a plan
does not allow distribution in the form of an annuity, a DRO related to that
plan cannot be qualified if it requires an annuity.
Amount of Benefits
An order cannot provide benefits greater than the benefits available to
the participant without the QDRO. For example, if a participant’s account
balance is $45,000, a DRO assigning benefits equal to $50,000 cannot be
qualified. That is why many orders describe the amount payable as a
percentage of the participant’s benefits rather than as a flat dollar
amount, especially in light of the economic volatility experienced over the
last several years.
Conflict with Previous QDRO
In the event a previous QDRO has assigned benefits to an alternate payee,
a subsequent DRO cannot assign those same benefits to a different alternate
payee. During 2010, the Department of Labor published new regulations
clarifying this issue. The regulations specify that receipt of a DRO after
an event such as a death or divorce or after receipt of another QDRO does
not necessarily mean there is a conflict. Rather, the substance of the
order(s) must be considered.
As long as payments under the first QDRO have not already commenced, a
subsequent order modifying the amount is not, per se, a conflict. Similarly,
if a participant who is already subject to one QDRO becomes subject to
another, there is no conflict as long as the subsequent order does not
attempt to assign the same benefits addressed in the first order.
All plans are required to have procedures that describe how DROs will be
processed and reviewed to determine their qualified status. Among other
things, the procedure should specify the timing within which the review will
take place and outline the flow of communication among the parties.
On receipt of an order, the plan sponsor should take immediate steps to
freeze loans and distributions of the participant’s benefits during the
review period. The freeze should generally remain in effect until the
- 18 months from the date the benefit was frozen;
- The date distribution is made to the alternate payee;
- The date the plan sponsor receives a court order releasing the
participant’s benefit from the freeze; or
- At the end of the 30-day appeal period that begins upon the alternate
payee’s notification the DRO has been denied if no appeal is filed.
Don’t Make Assumptions
While the rules described in this article are not necessarily
complicated, the facts and circumstances of each situation bring unique
details to be considered. As a result, each proposed QDRO should be reviewed
carefully. Whether it is identification of the plan from which benefits will
be paid or the calculation of the benefit itself or anything in between, any
confusion should be clarified with the attorneys representing the parties.
It may be tempting to make assumptions in the interest of expedited
processing; however, if those assumptions are incorrect and lead to improper
payment of benefits, the plan sponsor may be held liable to make the parties
whole. Although divorcing spouses are typically on opposite sides of the
negotiation, they can unite very quickly against an employer who has
incorrectly processed a QDRO.
Death and Taxes
As the saying goes, death and taxes are both unavoidable, and the same is
true with QDROs.
When an ex-spouse receives distribution of plan benefits pursuant to a
QDRO, he or she is responsible to pay the associated income tax. While this
may seem obvious, both parties do not always understand that fact.
Sometimes, however, the parties do understand and try to renegotiate the tax
There was a Tax Court case in 1996 that dealt with this very issue. The
QDRO in that case was written to shift the tax liability from the alternate
payee (the ex-spouse) to the participant, but the Court held that the terms
of a QDRO cannot override federal tax law and required the ex-spouse to pay
the associated taxes. This does not mean that the parties cannot negotiate
the principal amount of the QDRO payment to “gross-up” the alternate payee
for the anticipated tax liability.
Distributions made pursuant to QDROs are generally taxed in the same
manner as any other “typical” plan distribution (other than hardship
distributions or required minimum distributions). The alternate payee has
the option to receive payment in any form permitted by the plan, e.g., lump
sum, installment, etc. He or she also has the option to take the payment as
a cash-out or rollover into an IRA or another qualified plan. One key
difference is that alternate payees who elect a cash-out distribution are
not subject to the 10% early withdrawal penalty if the distribution is taken
directly from the plan.
The potential for QDRO-related confusion does not always stop when
payment has been made. It is not uncommon for a participant to assume that a
QDRO officially concludes any right that his or her former spouse may have
to retirement benefits. However, an ex-spouse may be listed as the
participant’s beneficiary. The federal courts see a number of cases each
year involving “unintended” payment of death benefits. The typical scenario
goes something like this…
A participant and second spouse go through a divorce, and the second
spouse receives half of the participant's retirement benefits via QDRO.
Fast-forward a few years to the participant's death. The participant has a
will leaving all remaining assets to his or her children from the first
marriage. However, the most recent plan beneficiary designation on file
lists the second spouse as the primary beneficiary, because the participant
forgot to file a new designation following the second divorce.
Since a beneficiary designation is considered a plan document, the
sponsor follows the form on file and pays all remaining retirement benefits
to the now-former second spouse. The children from the first marriage file
suit, naming the second spouse and the plan sponsor.
While the facts of each case are unique, the plan sponsor in this fact
pattern is generally correct in paying benefits to the person named on the
most recent beneficiary designation form. The participant’s will may
determine how assets outside the plan are paid but it has no bearing on the
payment of plan benefits. As a result, it is recommended as part of the QDRO
procedure that plan sponsors remind participants to update their beneficiary
Divorces can be messy, and financial negotiations can make an already
heated situation reach a boiling point. Understanding the rules of
engagement and clearly documenting procedures can keep the plan sponsor’s
role to one of “just business”and minimize the liability associated with
being pulled into the middle of an emotionally charged situation.
[top of page]