As a result of what is known as the anti-alienation rule, account balances in qualified retirement plans such as employee stock ownership plans (ESOPs) and 401(k) plans generally cannot be paid to anyone other than the participant or, in the case of the participant’s death, the participant’s beneficiary. An exception to this rule applies in the case of a qualified domestic relations order (QDRO), which can assign some or all of a participant’s balance to an individual designated as the alternate payee. Following are questions that commonly arise about QDROs.
When does a DRO become a QDRO?
A QDRO starts out as a domestic relations order (DRO), which is a judgment, decree, or order (including the approval of a property settlement). DROs are made under state domestic relations laws that relate to the provision of child support, alimony payments, or marital property rights for the benefit of a spouse, former spouse, child, or other dependent of the participant. A state authority must issue a judgment, order, or decree or formally approve a property settlement agreement before it can be a DRO. If the state agency is not a court, the agency in charge of enforcing child support orders generally will issue the DRO.
To be a QDRO, the DRO must, at a minimum, contain certain information such as:
- The name of the plan to which the order applies
- The name of the participant and each alternate payee’s name and last known mailing address
- The amount or percentage of the participant’s benefits to be paid to each alternate payee
QDROs become part of the public records in a divorce proceeding. Plan administrators will need the alternate payee’s Social Security number (SSN) for recordkeeping and reporting purposes (and might need the participant’s SSN to assure they can identify the correct participant). SSNs usually are provided in a separate document that is not part of the public record to comply with most state privacy laws that prohibit them from being included in public records. Similarly, if an order does not provide the last known address of the participant or alternate payee, but the address is reasonably available from other records or simple inquiry, the lack of address does not disqualify the order from being treated as a QDRO.
What can disqualify a DRO from becoming a QDRO?
An important aspect in the process of determining if a DRO is a QDRO is the ability of the plan administrator to determine the amount to be assigned to the alternate payee. In ESOPs and 401(k) plans, the DRO commonly will state that the alternate payee is entitled to a specific percentage of the participant’s benefit as of the date of divorce or of the benefit accumulated while the participant and alternate payee were married. Calculating the benefit based on the amount accumulated during a marriage can be difficult. For example, if the order assigns 50% of the participant’s balance accumulated during the marriage but records do not exist to determine the balance accumulated before the marriage, the order would fail to be treated as a qualified order because it is not possible to determine the amount to be assigned to the alternate payee.
Another common problem arises when an order provides that the alternate payee is entitled to a specific percentage of the participant’s balance as of a particular date that is not a valuation date. In these cases, the value commonly is determined using the most recently completed valuation date. Other times an order uses the participant’s balance as of a certain date or the closest valuation date to determine the amount due to the alternate benefit. When a plan is valued one time per year, what is the closest valuation date? Should the most recent preceding date or the upcoming valuation date, if closer, be used? In general, the most recently completed valuation date should be used even if a future valuation date is closer so that the value of the participant’s benefit would be known to the parties at the time the order was legally effective. However, the administrator should consult legal counsel for direction if there’s any question regarding the interpretation of closest valuation date.
When is an alternate payee entitled to a distribution?
Some plans have specific provisions stating when an alternate payee is eligible for a distribution. For example, a plan might have a provision allowing the plan administrator to make a distribution to an alternate payee as soon as administratively feasible following the date the DRO is determined to be a QDRO. Questions arise, though, when a plan does not have a provision relating to when the alternate payee is eligible for a distribution.
A QDRO may state the date an alternate payee is entitled to a distribution, but that date cannot be earlier than the participant’s earliest retirement age. In this context, the earliest retirement age is the earliest of:
- The date on which the participant is eligible for a distribution
- The later of either:
- The date the participant attains age 50
- The earliest date on which the participant could receive a distribution if the participant separated from service
When a plan states a participant is eligible for a distribution only upon separation from service, the alternate payee is entitled to a distribution at the earlier of the participant’s actual separation from service or age 50. For plans that apply a five-year delay, the payment date is the earlier of five years following the participant’s actual termination of employment or age 50.
If a plan states a participant is not entitled to a distribution until separation from service, but the QDRO states the alternate payee is entitled to a distribution upon the participant attaining the earliest retirement age, the QDRO provision overrides any plan provision that would result in the alternate payee waiting longer than the participant’s earliest retirement age. If the plan had a provision that permitted the alternate payee to receive a distribution sooner, that provision would apply.
If the plan does not have any specific provisions regarding when an alternate payee can receive distributions, and the DRO does not have the earliest retirement age provision, it’s likely the DRO would not be treated as a QDRO because the plan administrator would not be able to determine when the alternate payee was eligible for a distribution.
How is an alternate payee’s distribution paid?
A QDRO cannot require a plan to provide an alternate payee with any type or form of benefit or any option not otherwise provided under the plan. If the plan states that balances greater than a certain amount are paid in installments, the DRO cannot require the plan to pay in a lump sum. In such cases, the DRO would not be considered a QDRO because it is requiring the plan to provide a form of benefit that otherwise is not available.
Does an alternate payee need to consent to a distribution?
Consent typically is required for a distribution when the vested balance exceeds $1,000. There is an exception, however. A plan must provide an alternate payee the right to elect a direct rollover within a reasonable time (usually 30 days) and provide the applicable forms and notices. If the period elapses, and the alternate payee does not return the forms electing a payment, the plan can make a distribution without the alternate payee’s consent.
QDROs in a nutshell
QDROs can create administrative headaches. They arise due to life events that, in most cases, are stressful for the participant and alternate payee. The obligation to make a distribution from an ESOP to an alternate payee could affect a company’s financials by having to fund the distribution at a time it was not anticipated. The impact could be softened if the plan can make installment distributions to the alternate payee. As such, plan administrators should review their QDRO processes and procedures to help mitigate the administrative (and legal) issues that could arise when the next DRO lands on their desk.