She is currenty preparing QDROs and DROs only for her divorce mediation clients.
A QDRO (‘Qualified Domestic Relations Order’, and pronounced ‘quadro’) is a court order to a retirement account administrator that tells the administrator how and when to divide retirement benefits such as a 401K between spouses who have divorced.
A separation agreement (“divorce agreement”) between divorcing spouses that specifies how retirement accounts should be divided is not enough for a pension or retirement plan administrator to divide accounts or benefits. Even when that separation agreement has been signed by a judge and the divorce is final, that is not enough for a retirement plan administrator to divide an account. Plan administrators will only divide retirement assets if they have a QDRO (or equivalent documents such as a DRO or COAP).
The US Department of Labor gives a good overview of QDROs in this 4-page document. (They also provide a 120-page explanation of QDROs in this document.) The legal basis for a domestic relations order to count as “qualified” is laid out in federal law in the 1974 Employee Retirement Security Act (ERISA). You can read the actual language in Section 206, which starts on p. 98 of the 500+ page ERISA document.
The Massachusetts Teachers Retirement System (MTRS) provides a 40-page guide to MA DROs. (You must be careful with this guide, however. The sample DRO they give suggests a formula–on p. 18, paragraph 5–that most DRO experts find unfair. Their sample DRO formula freezes “Years of Service”–illustrated with Line 4 “Freeze Y of S” in the chart that you can see on this page–which could cut the alternate payee’s benefit by almost half.) See this section about MA formulas for pension division to learn more about legal–but not necessarily fair–ways of dividing MA public pensions. You can can read the most complete available description of how to divide MA state pensions in divorce here.
QDROs must bridge and comply with both federal and state law. Marriage and divorce law is state-specific. Separation agreements (divorce agreements) and the judges who approve them tend to focus on state marriage and property laws.
Retirement account administrators who approve QDROs in contrast, are oriented to federal ERISA and labor laws, which are designed to protect the rights of retirement plan participants. For state employees, the administrators are guided by state labor and pension laws, which, like ERISA, are designed to protect workers by preventing anyone from getting access to the worker’s retirement money or pension.
A QDRO bridges the gap between state-specific divorce law documents and (often federal) pension protection laws. Because of this gap between state marriage laws and (often) federal labor laws, many divorce lawyers do not adequately specify how retirement assets are to be divided when they draft their separation agreements. See “When do I file my QDRO”, below, for a description of the problems caused by separation agreements drafted by lawyers unfamiliar with the details and specification of contingencies required by QDROs.
Dividing retirement assets with a QDRO involves multiple steps.
A quick survey of websites suggests that QDRO’s in MA are typically in the $600-$800 range, but they can go as low as $300 for a service that only produces a QDRO document (and does not make sure that it is acceptable to the plan) to as high as $1000 for service that goes through all six of the steps above.
If you are comparing QDRO preparation prices, be sure to compare how many steps of the QDRO Process are included. Many QDRO preparers only do Step 1. If a QDRO preparer only does Step 1, you are left in a position where you don’t know if the QDRO will be acceptable to the retirement plan. You can go to considerable time and expense to get the QDRO signed and certified by the court, and then have it rejected by the plan administrator, in which case you have to start all over again. If the QDRO preparer only drafts the QDRO and gets pre-approval, then you have to hire another lawyer to draft the court motion or figure out how to draft a legal motion on your own.
The entire QDRO process typically takes 2-6 months or longer, even if the QDRO preparer has a draft of the document within a week. It takes this long because it involves coordinating many steps among many people: the ex-spouses, their lawyers, the judge, and the plan administrator. Even if each party takes only a few days or a week to do their part in moving the process to the next step, these successive steps quickly add up. If a pension administration office is understaffed, which is often the case for MA state pensions, the pension administrator may take many weeks to respond to preapproval requests or other correspondence.
Anyone dividing retirement accounts (except for IRAs) in a divorce needs a QDRO. You need a QDRO to divide a pension or retirement accounts such as 401k’s, 403b’s, 457’s, and Thrift Savings Plans. You do not need a QDRO to divide an IRA—the spouses themselves are the administrators of their IRA’s, so they can divide their IRA’s according to the terms of their divorce agreement without a QDRO. You do not need a QDRO if you are sharing a pension by using a present value calculation and buying out the non-participant spouse at the time of divorce (“immediate offset method”).
It is possible to file your QDRO any time after you divorce (but before pension benefits begin), BUT you should always have your QDRO prepared at the same time that your divorce agreement is being prepared, and you should file it as soon as your court allows it, especially if you have a traditional, defined benefit pension.
In certain situations when a pension participant dies before a QDRO is filed, the ex-spouse could lose the hundreds of thousands of dollars of benefits to which he or she would otherwise be entitled.
The reason for preparing QDROs at the same times as the divorce agreement is prepared is simple: most divorce lawyers (and do-it-yourselfers) do not understand retirement account laws very well. This results in poorly written divorce agreements that do not clearly specify how the accounts should be divided and that fail to address contingencies, especially with pensions. Judges in MA regularly sign off on these divorce agreements when they sign the divorce decree, even if the agreement does not adequately specify how retirement accounts are to be shared. This creates problems when the QDRO is later drafted. In Massachusetts, for example, a separation agreement that specifies only that the “marital portion of the pension shall be divided equally” can be interpreted and calculated in up to 8 different ways, resulting in very different financial outcomes for the ex-spouses. See the chart at the bottom of this page to see how much variation there can be when “dividing a pension equally.”
QDRO’s are extremely specific and detailed. They specify the exact method for dividing retirement accounts, and they cover many contingencies (e.g. accidental or ordinary disability; remarriage of the alternate payee; exact timing of death of the participant, etc.) that can have large financial consequences, especially with defined benefit plans.
If the QDRO is drafted after divorce is final, the QDRO preparer must include details about how the retirement accounts are to be divided that the spouses may never have been aware of, understood, discussed, agreed to, or specified. A QDRO could then be seen as favoring one spouse or the other. This can lead to expensive and exhausting court fights, long after ex-spouses thought that all issues had been resolved.
If the QDRO is prepared at the same time as the separation agreement, the QDRO preparer will force the divorcing spouses and their divorce lawyer(s) to understand, negotiate, and specify all relevant issues in the divorce agreement. This is why some states, such as California, require that QDROs be filed with all other divorce documents at the divorce hearing.
Paradoxically, at least one MA county probate court, Hampden County, will not sign and certify a QDRO until the divorce is “absolute” (which occurs 120 days after an uncontested divorce “1A” hearing and 90 days after a contested divorce “1B” hearing). These QDROs should still be prepared, however, at the same time the divorce agreement is negotiated, even if the QDRO is actually filed somewhat later.
The filing of the QDRO is then just an administrative step, in which documents are handed over to the court. By preparing the QDRO at the same time as the divorce agreement, the divorcing couple will understand and agree to the substance of the QDRO, which will be recorded both in the QDRO and the divorce agreement.
While poorly written divorce agreements have the largest financial consequences when dealing with defined benefit pension plans, they can also cause problems with dividing 401k-type (defined contribution) plans. A poorly drafted divorce agreement can mean that QDROs divide retirement assets in ways that were not understood or intended by the spouses. In some cases, a poorly written divorce agreement can require that a QDRO be drafted for each individual retirement account, resulting in thousands of dollars of QDRO preparation costs.
The participant is the person who has the retirement account or pension from their job. They “participated” in the retirement plan from their job.
The alternate payee is the other spouse, who will receive part of the retirement assets as specified in the divorce agreement.
The QDRO or DRO is the legal document that allows a retirement account administrator to release money to an alternate payee. In the context of divorce, the alternate payee is nearly always the ex-spouse, but under federal law it can also be a child or dependent of the participant.
There are many thousands of retirement plans in the United States, and thousands of different forms and specifications for the QDRO’s or DRO’s that particular pension administrators will accept. Below, you can download 3 sample forms, two of which illustrate ways of dividing defined benefit plans (traditional pensions) and the other of which illustrates several ways of dividing a defined contribution plan (401k’s and similar plan).
The way you divide retirement accounts in divorce depends on the type of retirement plan, as explained and illustrated with an infographic on this division of marital property in divorce page.
The first sample QDRO form for a traditional pension illustrates language for sharing monthly pension benefits when the dollar amount of those benefits has already been determined (e.g., the pension participant has already left service and is not accruing additional pension credits). In this example, the language under Section 6 AWARD OF ALTERNATE PAYEE’S INTEREST, specifies that the non-participant spouse is awarded either a specific dollar amount or a percentage of each benefit payment. For pensions with COLA’s (cost-of-living-adjustments), specifying a percentage assures that the alternate payee shares in the increased benefits over time.
The second sample QDRO form for a pension gives an example of language for dividing future pension payments. This QRO is drafted while the participant is still working and accruing pension credits. This formulation allows a pension administrator to determine an alternate payee’s share of each pension benefit payment even if the pension participant continued to work for many years after divorce, accruing an ever larger pension.
The key language in this example is in Section 6 AWARD OF ALTERNATE PAYEE’S INTEREST, which specifies the formula that the pension administrator should use in calculating the percentage of the total pension benefit that should go to the alternate payee versus the percentage of the total benefit that should go to the participant. In many states, the pension administrator will divide the number of pension credits earned during marriage by the total number of pension credits earned by the participant, yielding a marital portion of the total pension, i.e., the fraction of the percentage that belongs to the marriage. In many cases, this marital portion of the pension is then divided 50-50 between the (ex-)spouses.
The third sample QDRO form 401k-type shows language for several different ways of dividing a 401k-type (“defined contribution”) plan. In Section 3, Amount of Alternate Payee’s Benefit, this QDRO template illustrates language for 4 different ways of dividing a 401k-type pension savings plan. The differences in these ways have to do with two variables: whether 1) the alternate payee receives a percentage or a specific dollar amount of the 401k balance, and 2) whether or not the amount of money specified in “1)” is adjusted for gains or losses in the account that occur between the date specified in the agreement and the date that the money is actually transferred to the alternate payee.
Yes, you can, if you are the alternate payee, and you can avoid the 10% early withdrawal penalty that is normally imposed on 401k withdrawals before age 59-1/2. You will, however, have to treat the withdrawal as income and pay normal federal and state income taxes on it.
This cash withdrawal can only come from “qualified plans” (typically 401k’s and 403b’s), so the money must move directly from the participant’s 401k into cash or a 401k in the alternate payee’s name. If it is first moved into any kind of IRA, it can no longer be withdrawn free from the 10% penalty.
The retirement plan administrator will withhold 20% of the cash withdrawal for federal taxes and between 2% and 8% (depending on the state you are in) for state taxes.
You have not yet avoided the 10% penalty, however. That comes when you prepare your federal income taxes. The retirement plan informs the IRS of your early withdrawal, and the IRS will expect you to pay that 10% penalty with your taxes.
You need to fill out and file an IRS Form 5329, “Additional Taxes on Qualified Plans” to avoid the penalty. On Line 2 of this form 5329, you can enter the code “06” (where it says, “Enter the appropriate exception number from the instructions: ___”) and then specify the amount of the early withdrawal that should not be subject to the 10% penalty.
Instructions for IRS form 5329 describe 12 different codes that can be used to avoid the penalty. Code “06”, the relevant one here, specifies: “Qualified retirement plan distributions made to an alternate payee under a qualified domestic relations order (doesn’t apply to IRAs).” Remember it is only the alternate payee, the person who is receiving money from the ex-spouse’s account that can do this penalty-free withdrawal. The plan participant is not able to make a penalty-free withdrawal.
A “separate interest” is a way of dividing a defined benefit pension that essentially creates a separate pension account for the alternate payee using part of the benefit of the participant. This separate pension account, once created, is relatively independent of the participant’s account. This allows the alternate payee to begin drawing benefits, for example, as soon as plan rules allow it (e.g., at the alternate payee’s minimum retirement age) regardless of whether the participant retires or continues working. This independence from the participant’s account may also allow the alternate payee to choose a form of receiving benefits that differs from the form chosen by the plan participant and may allow the participant to specify new survivor beneficiaries for their accounts.
In Massachusetts, “separate interest” is not allowed by Massachusetts public employee pensions, which account for the majority of MA pension participants. It is, however, possible for private, defined benefit pension plans in Massachusetts.
Creating a separate interest through a QDRO has the advantage of allowing each ex-spouse a degree of independent control over their benefits.
There can be disadvantages to this independence if one of the ex-spouses is unlikely to survive very long.
If the alternate payee is unlikely to survive very long, a shared interest division can benefit the participant. With a shared interest division, the alternate payee’s portion of the pension reverts to the plan participant if the alternate payee dies first. With a separate interest division, the alternate payee’s benefits simply cease upon death, and the company pockets the savings.
If the participant is unlikely to survive very long, a shared interest division can benefit the alternate payee as long as the pension allows a survivor benefit for an ex-spouse. Some pension plans have a survivor annuity that can bump up the alternate payee’s benefit above the amount established in the divorce agreement (e.g., through a marital coverture ratio) if the participant dies. A Massachusetts private company pension might specify a survivor annuity benefit that is 50% of the participant’s benefit. The percentage received through a marital coverture ratio is typically lower than 50%. For example, if a plan participant accrues pension credits for 20 years and is married for 10 of those years, the alternate payee typically only receives one half of the marital portion of the pension, or 25% of the participant’s benefit. The higher survivor annuity benefit is only possible with the shared interest division. Some private pensions, such as the New England Carpenters Pension Fund, do not allow a survivor benefit for an ex-spouse.
A final consideration is the actuarial calculation of the alternate payee’s benefit with a separate interest pension account. Because this account is independent of the participant’s account, the company will use the alternate payee’s age not only for allowable benefit start dates, but also for the calculation of the actual benefit. If the alternate payee is much older than the participant, the monthly benefit will be relatively higher (because the company assumes they will not have to make payments for too many years), and if the alternate payee is much younger, the monthly benefit will be relatively lower (because the company assumes they will have to keep paying benefits for many years to come).