Divorce Without Going Broke
By Janet Bouma, Certified Divorce Financial Analyst
Dividing Retirement Accounts in Divorce - Part I
As a Certified Divorce Financial Analyst (CDFA), I work with divorcing clients and their attorneys, and/or mediatorsdealing with all the financial aspects of divorce. Time and time again, questions arise regarding the disposition of retirement plans.
There are two types of retirement plansdefined contribution plans and defined benefit plans. A defined contribution plan provides an individual account for each participant. The benefits are based on the amount contributed and are also affected by income, expenses, gains and losses. Some examples of defined contribution plans include 401(K) plans, 403(b) plans, employee stock ownership plans and profit sharing plans.
A defined benefit plan (commonly called a pension) promises the participant a specific monthly benefit at retirement, which is usually stated as an exact dollar amount. Some defined benefit plans allow the participant to take a lump sum at retirement, rather than the monthly benefit. Most pensions are calculated by a formula that considers a participant's salary and service. A participant is generally not required to make contributions in a private sector fund, but most public sector funds require employee contributions. Unlike defined contribution plans, the participant in a pension is not required to make investment decisions. About 90% of the pensions held in the United States are held by men. Here in Pittsburgh, we have quite a few companies that offer pension plansPPG, Alcoa, Westinghouse, Usairways, to name a few.
In 1974, The Employee Retirement Income Security Act of 1974 (ERISA) was enacted to protect the interests of employees who participate in employer-sponsored pension plans. ERISA contains language that prevents a plan participant's benefits from being assigned or alienated in anyway. It contains a spendthrift provision that assures that a plan participant's benefits under the plan are maintained solely for that individual's benefit and cannot inure to the benefit of another person.
There are some very limited exceptions to the antialienation provision. One is a Qualified Domestic Relations Order (QDRO) that meets the criteria enumerated in ERISA and the Internal Revenue Code. A QDRO is basically a state-issued domestic relations order that relates to the provision of child support, alimony payments, or marital property rights to a spouse, former spouse, child or other dependant of a plan participant. QDRO's are most frequently used in the division of ERISA governed retirement plans in divorce.
Let's talk first about dividing a defined contribution plana 401(k). Participant's of 401k plans receive statements every month if there is activity in the account; quarterly if no activity; and no less than one time per year. The statements indicated the value of the Plan as of the date of the statement. Most plans will be able to tell you the value of your account on each day of the year;, or you can get the value by looking at an investment statement that is close to your date of separation, or whatever date you are using to value the asset.
In all ERISA- governed plans, you have a Plan Participant, who is the person participating in the Plan, and the Alternate Payee, the spouse who is receiving the funds from the Participant, in a divorce, via a Qualified Domestic Relations Order (QDRO). Let's say that your attorneys have negotiated the final terms of your divorce and a Property Settlement Agreement (PSA) has been written and signed. (Note: Both spouses can mediate the terms of their divorce, but they still should always use attorneys in this process.) Let's say that the wording states that one spouse is awarded 50% of the marital portion of the other spouse's 401k, as of a certain dateusually the date of separation or date of divorce. Often, that is the only statement that appears in the PSA regarding dividing that retirement plan.
Now a QDRO needs to be written in order to effectuate the transfer of funds from the Plan Participants 401k to the Alternate Payee. Who should take responsibility for preparing the QDRO? The attorney who represents the spouse who is getting the money (Alternate Payee) should take the responsibility of having the QDRO drafted. You might as, "Why is that?" And the answer is that a QDRO is NOT a neutral document. It can be written to benefit one party over the other. If you are on the receiving end of the QDRO funds, you need to make sure that your interests are protected, most especially from the death of the Plan Participant before the funds are transferred to you.
Timing is a very important issue relating to QDROs. What if the QDRO is not written at the time the divorce is finalized? You get divorced; your ex-spouse remarries and changes the beneficiary on his/her 401k to the new spouse, and then your ex-spouse unexpectedly dies? The new spouse is the beneficiary and you are not, if a QDRO has not been written and approved by the courts and then by the Plan Administrator.