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QDRO Drafting Strategies Avoiding Pitfalls That Result in Unintended Loss of Retirement Plan Benefits
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TUESDAY, JUNE 5, 2012
Presenting a live 90-minute webinar with interactive Q&A
Carolyn A. D'Agostino, Attorney, Law Office of Carolyn A. D'Agostino, Albany, N.Y.
Emily Widmann McBurney, Shareholder, Kegel McBurney LLC, Atlanta
Pamela D. Perdue, Of Counsel, Summers Compton Wells, St. Louis
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Introduction
Carolyn A. D'Agostino, Attorney, Law Office of Carolyn A. D'Agostino,
Albany, N.Y.
Emily Widmann McBurney, Shareholder, Kegel McBurney, Atlanta
Pamela D. Perdue, Of Counsel, Summers Compton Wells, St. Louis
1) Pension Negotiation Strategies and a
Checklist for Agreements: Carolyn A. D’Agostino, Esq.
2) QDRO Drafting Issues and Pitfalls: Emily Widmann McBurney, Esq.
3) Reviewing Draft QDROs: A Plan’s Perspective: Pamela D. Purdue, Esq.
4) Best Practice Tips
5) Q&A (time permitting)
Pension Negotiation Strategies and a Checklist for Agreements
Carolyn A. D'Agostino, Esq.
21 Everett Road Ext. Albany, NY 12205
(518)489-1098
10
Why is the negotiation of retirement benefits a minefield for the matrimonial attorney?
Must be in the Agreement to be assured of spouse obtaining the benefit.
Pension may be the only asset in the marriage of any value.
Offset may not be in your client's best interest. Attorneys must be aware of pension valuation
concepts before negotiating any type of retirement division.
11
Methods of Division
Lump Sum Buyout Asset Swap Deferred Distribution
12
Pension Terminology:
Understand the differences between types of retirement assets and the vocabulary used to divide them.
13
Defined Benefit “DB” Plans
Traditional pension plan Participant's benefit is calculated to a specific
formula Participants do not have an “account” or an
“account balance.” Accrues more value at the end of the
participant's career
14
DB Plans Terminology: Accrued Benefit:
− Monthly payment that the participant can expect to receive at his or her normal retirement date.
− calculated according to a formula which generally uses salary and years of service as components.
Earliest Retirement Age: − Earliest age that Participant can receive a (reduced)
benefit
Normal Retirement Age − Age at which Participant can receive an unreduced
benefit 15
Vesting The amount of service credit an employee must
accrue before being guaranteed a benefit upon retirement.
Valuation of an unvested pension is highly speculative. Present value of pension will be further reduced to reflect the probability that the pension will not vest.
16
Subsidies, Supplements, and Other Benefit Enhancements
Early retirement subsidies Early retirement incentives in the form of additional
service, COLAS
17
Defined Contribution Plans
401(a), 401(k), 403(b), 457 plans Retirement is in the form of an individual
account balance. Employer may or may not make matching or
periodic contributions. Employee compensation is tax-deferred until
retirement or (in some cases) separation from service
18
DC Plans Terminology
Account Balance − The value of benefits as of a specified valuation date
under a defined contribution plan. − May consist of one or more subaccounts. − May be invested in one or more investment funds. − How are these funds being invested by the
Participant? − Is the account balance encumbered by loans? − Pre-marital account balance?
19
DC Plans:
Employer Contributions: allocation of employer contributions made to account after the date of commencement, but which may relate back to pre-commencement employment.
Example: Company pays its 401k contribution in December, but parties split in June. Be sure to allocate this anticipated contribution when negotiating alternate payee's share.
20
Investment Experience
Who will bear the risk of loss of value? Will the Plan make this calculation? Pre Marital Contributions and Gain/Loss Post Marital investment experience What to do in a volatile market?
21
Methods of Valuation
Tracing method Value Difference (subtraction) Fractional shares Use of a stipulated rate of return
22
Tracing
Most accurate Pre-marital contributions and earnings on contributions Contributions made during marriage and gains/losses
on those contributions Calculate aggregate rate of return from date of
marriage until date of cut-off Date of cut-off until date of plan distribution = total
marital portion. Time weighted: ex. Marital contributions in first year of
marriage have largest return due to compounding. 23
Tracing, cont'd
Post marital losses: how are they to be allocated?
Trace losses from date of cut-off (commencement of action) to date of valuation
Look at aggregate rate of return from date of cut-off to date of valuation by plan.
24
Subtraction Method
Pre-Marital account balance subtracted from total as of Date of Commencement
Net amount divided 50/50, with gains/losses to date of distribution
Assigns all of pre-marital gain to marital portion
25
Coverture Method
Applies coverture to proportionately divide account balance to marital and non-marital components
Least accurate method, generally not appropriate to divide a DC plan unless data is unavailable
Assumes that contributions pre-marriage were at the same rate as contributions during marriage.
26
Risk
Gains/Loss: in a declining market, failure to include G/L in Agreement puts risk of loss on Participant
In bullish market, Participant would bear all of the gain.
Who bears the risk?
27
Cash Balance Plans
Hybrid between DB and DC plan Benefits expressed as “account balance” Employee receives “credits” each year, often tied to
salary Employee may also receive “interest credits” At retirement, the “account balance” is converted into an
annuity. Lump sum payout possible
28
Valuation and Division of Cash Balance Plans:
Will be much lower than DB plan valuation (because in a DB plan most of the value accrues in the last few years before retirement).
Value at Date of Commencement will be more accurate “snapshot” of spouse's share at retirement
29
IRAs Same Valuation issues as DC Plans IRA Administrators generally will NOT calculate investment
gain/loss. May need to trace IRAs moved or rolled into other IRAs.
Very difficult to assess pre-marital portion if separate accounts have not been kept.
Better tax implication for AP if IRA amount is pulled from the 401K or other qualified plan
30
Benefits of Immediate Offset: − Spouse will receive other marital assets of
comparable value. − Parties are better able to disentangle financial
affairs − Spouse can build and pass on an estate with the
assets received − If Spouse is ill or older, deferred distribution is of
no benefit
31
Immediate Offset, cont'd
− Spouse may beat the Plan by investing the lump sum. Any investment which outperforms the discount rate will result in a greater benefit for the Spouse.
− Spouse may need cash. − Age differences between spouses: AP is
significantly older than P; deferred distribution may not make sense
32
Deferred Distribution via QDRO − AP will obtain a lifetime stream of payments − Coverture fraction will allow for inflationary protection for
AP − Guaranteed source of income in retirement years − Risk (or lack thereof) associated with the pension is
shared between the parties. − Spreads different growth rates of different types of
retirement assets between the parties. − May not be enough other assets in marital estate for
offset to occur.
33
Actual Realities Leaving aside actuarial assumptions, assess
the following case-by-case: − Health of Participant and Spouse − How long has Participant worked in the covered employment? − Is Participant likely to stay in the covered employment until
retirement age? − Does the Plan change the benefit calculation formula the
greater the years of service in the Plan? − What is the Participant's likelihood of future salary increases? Is
he or she on a fast track? − If the Participant takes early retirement, how much of a
reduction in benefit will be imposed by the Plan?
34
Defined Benefit Methods of Division:
Coverture − Marital portion of the pension is determined by
multiplying the accrued monthly benefit by a fraction, the numerator of which is the number of months of service accrued in the plan during the marriage and the denominator is the total service in the plan as of the date that benefit accruals ceased.
− Each spouse gets 50% multiplied by the “marital portion” as determined by coverture.
35
“Frozen” Coverture: Beware! − Benefit calculated and frozen as of date of
commencement. − No inflationary protection for alternate payee. − Benefit to participant: shelters future increments to
salary post-divorce from alternate payee − Ex.: P’s attorney wants salary and service to be set at
date of commencement levels.
36
Getting the Money Out:
− Do not assume an immediate distribution is possible. − QDRO should state that Alternate Payee should be
entitled to receive benefits in any available option under the plan, including a lump sum distribution, if permitted, but should not require lump sum distribution.
− Direct Rollover or Payment to AP (IRC Section 72: QDRO allows payment to AP without penalty – AP can pay expenses, then put remainder into an IRA)
37
Client Relations:
− Was client advised of necessity of pension valuation (if client declined, get disclaimer)
− explain deferred distribution vs. immediate offset − Effect of remarriage before 55 (federal and military) − Effect of actuarial reductions − Forfeiture scenarios explained − Disability issues discussed and addressed? − Risk of Delaying QDRO filing explained
38
QDRO Drafting Issues and Pitfalls
Emily W. McBurney Kegel McBurney LLC
Atlanta, Georgia [email protected]
39
The Sooner, the Better
• Get information about the retirement plans
early – during the negotiation process. • Do not finalize an Agreement or go to trial
without understanding the type of benefits involved.
40
Find Out:
• Type of Plan (Defined contribution? Defined benefit? Cash Balance? IRA?)
• Qualified? Non-qualified? Government? • Full legal name of the Plan • Account statement / benefit summary
41
Defined Contribution Plan • Employee and employer contribute to a specific
account for employee
• Account value fluctuates with the investments within it
• The amount of the contributions is what is “defined”
Example: 401(k) Plan
42
Defined Benefit Plan
• No specific account for employee
• Benefit based on years of service and salary
• The amount of benefits is what is “defined”
Example: traditional pension plan
43
Cash Balance Plan
• Hybrid of Defined Contribution and Defined Benefit Plan
44
Contrary to popular belief, you do NOT need a QDRO to divide an IRA.
• Trustee-to-trustee transfer pursuant to a decree of divorce or written instrument (such as a settlement agreement) incident to a divorce under 26 U.S.C.A § 408(d)(6).
• Copy of divorce decree and Settlement Agreement, plus a letter of instruction or form from institution should suffice to transfer IRA funds.
45
Qualified v. Non-Qualified Plans Non-Qualified Plans are:
• Not subject to ERISA
• Usually NOT divisible by QDRO (but a few do permit division by DRO)
• Generally unfunded and not secured (at risk if company goes bankrupt)
• Not guaranteed
• Subject to conditions (such as continued employment)
46
Non-Qualified Plans have terms in their names such as:
• Supplemental
• SERP
• Non-qualified
• Excess Benefit
47
• Many state and local government retirement plans are simply not divisible – confirm this in advance.
• Federal government and military retirement plans are divisible, but not subject to ERISA. Subject to very complex and specific rules – do not attempt to do this without experience or expert advice
48
• Full legal name of the Plan can provide a lot of information about the type of Plan.
• Account statements can also reveal important information about the nature of the Plan, the benefits, existence of loans, survivor designations, and restrictions.
49
Contact the Plan Administrator and get QDRO procedures and model order.
Find contact information:
• On account statements
• At http://freeerisa.benefitspro.com
• From employee
• It often takes several phone calls to get to the person who handles QDROs for the Plan.
50
Model Orders • Helpful tool or gateway to malpractice
• Plan cannot require you to use the model
• Attorneys should never blindly use the model – have to be sure that the model will provide the benefits as awarded in the divorce.
• Online QDRO generating systems (Fidelity, Hewitt) can be a great way to streamline the process – but there are pitfalls if the case does not fit the template.
51
Prepare a draft QDRO and send to Plan Administrator to review before sending to court. • Some large QDRO processors will not
review drafts (e.g., Fidelity).
• Follow up once a month for response.
52
Issues that must be addressed in QDRO:
• Date of division
• Earnings and losses (defined contribution plans)
• Loans (defined contribution plans)
• Surviving spouse benefits (most important for defined benefit plans)
53
Date of division:
As of what date are the benefits to be divided?
• Date of divorce?
• Date of separation?
• Date of Agreement?
• Date of retirement? • Any other date?
54
Earnings and losses (defined contribution plans only)
• Will the Alternate Payee’s benefit be adjusted for earnings and losses between the date of division and the date of distribution?
• This makes a BIG difference – especially in volatile markets.
• Must be specified in the QDRO.
55
QDRO must indicate whether loans will be included or excluded
from calculation of benefit awarded.
56
Surviving spouse benefits:
• MUST be addressed – especially for defined benefit plans.
• Distinction between pre- and post- retirement survivor benefits – BOTH must be addressed or result could be contrary to the parties’ intent.
57
• After the draft QDRO has been approved by the Plan Administrator, have the parties sign it as a consent order if possible.
• Obtain certified copies from the court and send to the Plan Administrator.
58
Follow up with the Plan Administrator!
NEVER close your file until you have confirmation that the QDRO has been approved and implemented. You should receive a formal letter from the Plan. Read the letter and make sure it is consistent with the intent of the QDRO!
59
For a defined contribution plan, confirmation might only come from your client – that the funds have been transferred to the client (or from the client’s account).
For a defined benefit plan, you must have a
letter. Keep a copy of the letter! It may need to be
produced 20 years from now if the Plan claims there was no QDRO (after the Participant dies or retires).
60
REVIEWING DRAFT QDROS: A PLAN’S PERSPECTIVE
Pamela D. Perdue Summers, Compton & Wells, P.C.
St. Louis, Missouri; [email protected]
Summers Compton Wells 61
What the Plan Looks for:
Does it satisfy the requirements to constitute a Qualified Domestic Relations Order (QDRO), and
Can the Plan comply without running afoul of its own provisions
Summers Compton Wells 62
What the Plan Looks for:
To constitute a QDRO, the order must: satisfy a list of Dos, and avoid a list of Don’ts
Summers Compton Wells 63
Dos to be a QDRO
In order for a Domestic Relations Order (DRO) to be a QDRO, the DRO must:
1. assign all or part of the Participant’s vested account or benefit to an Alternate Payee (AP)
2. relate to the provision of child support, alimony or marital property rights;
Summers Compton Wells 64
Dos to be a QDRO
3. specify name and mailing address of both Participant and AP
4. specify amount to be paid to AP, and 5. identify Plan to which DRO is directed
[ERISA Section 206(d)(3)]
Summers Compton Wells 65
Who is an AP
AP limited to spouse, former spouse, child or other dependent of Participant • If order requires payment to anyone
other than a bona fide AP, Plan will not approve as QDRO
Summers Compton Wells 66
What the Plan Looks for:
Limited to AP EX:
DRO requires plan to pay 50% of Participant’s vested account to former spouse, plus $10,000 to spouse’s attorney.
Plan Rejects—order requires payment to someone other than an AP
Summers Compton Wells 67
What the Plan Looks for:
Limited to AP Authority, however, for approval of DRO
requiring payment to various state child support agencies
[see, e.g., Advisory Opinion 2002-03A, 06/07/2002; Advisory Opinion 2001-06A, 06/01/2001]
Summers Compton Wells 68
What the Plan Looks for:
Limited to AP EX: Order provides that any benefit assigned to
the AP which remains unpaid on AP’s death is to go to the AP’s new spouse in a lump sum.
Many plans will reject for non-AP qualifying beneficiary. Law is unsettled. Consult with individual plan before specifying.
Summers Compton Wells 69
What the Plan Looks for: Must specify payments EX:
DRO directs calendar year Pension Plan to assign 50% of Marital Portion of Participant’s vested benefit.
Marital portion specified as determined using fraction with “marital participation from 1/1/1992 to 7/31/2010—a total of 211 months.”
Summers Compton Wells 70
What the Plan Looks for:
Must specify payments Plan rejects based upon failure to specify
amount to be paid or clear manner to determine
Conflict between fractional participation formula(i.e., January 1, 1992—7/31/2010 which is actually 223 months) and DRO’s specification of 211 months.
Summers Compton Wells 71
What the Plan Looks for EX:
DRO provides for payment to AP “on or after the Participant attains the earliest retirement age under the Plan.” However, the order fails to define the term “earliest retirement age.”
Plan Rejects—Could mean Earliest Retirement Age as defined in the Code, or could intend reference to plan’s early retirement age or something else
Summers Compton Wells 72
Avoid the Don’ts
In all events, DRO will fail to constitute a QDRO if the order: 1. requires a type, form or option not
allowed under the Plan; 2. requires the Plan to provide increased
benefits, or 3. requires payment of benefits that infringe
on an earlier AP’s rights to benefit
Summers Compton Wells 73
What the Plan Looks for:
Type, form or option not allowed under Plan EX:
Small Plan with a single valuation date receives a DRO requiring division on date of divorce—which is not a Plan valuation date.
Plan rejects –order requires a type or form or option not otherwise allowed under the Plan.
Summers Compton Wells 74
What the Plan Looks for:
Type, form or option not allowed under Plan EX:
DRO purports to assign 50% of the “plan value on August 31, 2010 plus gains.”
Plan Rejects—DRO purports to assign more than the Participant’s vested account
Summers Compton Wells 75
What the Plan Looks for:
EX: DRO states that AP shall be entitled to
all of the rights, benefits and options to which the Participant would be entitled.
Plan Rejects—technically AP has the status of a beneficiary not a participant under the law. Plan terms may grant lesser rights to beneficiary than to Participant.
Summers Compton Wells 76
Changes to be Aware of:
Until recently, courts were divided as to the legitimacy of an order as a QDRO issued nunc pro tunc
Subsequent legislation revised rules Now, DRO can be a QDRO even though it
amends a prior QDRO or even if issued after the death of the Participant. [Labor Reg. Section 2530.206(b)(2), Ex. 1; Labor Reg. Section 2530.206(c)(2), Ex. 1] Summers Compton Wells 77
Best Practices
Pamela D. Perdue Summers Compton Wells
Emily Widmann McBurney Kegel McBurney LLC
Carolyn A. D'Agostino Law Office of Carolyn A. D'Agostino
Summers Compton Wells 78
Best Practice Tips
Before drafting, ask for the Plan’s QDRO information and Summary Plan Description • More plans than you are aware will contain
special provisions allowing immediate distribution to an AP
Omit unnecessary tax information--Many Plans will reject DRO that contain incorrect tax information.
Summers Compton Wells 79
Best Practice Tips
Avoid drafting your DRO using provisions found in litigation
• Often the provisions are either completely
inappropriate for the plan at hand or cause the DRO to be internally inconsistent
Summers Compton Wells 80
Best Practice Tips Where the Participant’s account balance
includes the value of a loan, please be clear in drafting as to how the loan is to be treated
is the loan included or excluded in determining the underlying value of the account;
is the loan included or excluded for purposes of assigning distribution to the AP
Summers Compton Wells 81
Best Practice Tips
Please specify what the Plan is to do in the various “what if” events • what if the Participant dies before qualification
as a QDRO or before distribution to the AP? • what if the AP dies before qualification as a
QDRO or before distribution to the AP?
Summers Compton Wells 82
Best Practice Tips
If one party is to not bear any future losses, the DRO MUST be drafted to ensure that no other participant under the Plan not party to the DRO could be adversely affected
Summers Compton Wells 83
Best Practice Tips
Have your draft DRO approved by the Plan before approval by the court
Summers Compton Wells 84
Best practice tips:
Check in advance whether the Plan will charge an administrative fee (defined contribution plans only) to review the QDRO. Specify in the Settlement Agreement whether this fee will be split between the parties, or if one party will be solely responsible for the administrative fee. The Plan will have a default for how the fee will be paid if the QDRO is silent, but you can generally have the fee handled differently if it is set forth in the QDRO.
86
Best practice tips:
Review the model order in advance (during negotiation). You can often save a lot of money by tailoring the division of the retirement so that you can use the model order and make the QDRO process go more smoothly and without excess administrative fees.
87
Best practice tips:
Do NOT put the parties’ Social Security Numbers in QDROs – even if the model order indicates that this is required.
Insert “will be provided to the Plan Administrator under separate cover” in the line for SSNs, and include the SSNs in your cover letter when you submit the QDRO. Same is true for birthdates.
88
Best practice tips: Do NOT have a non-lawyer handle a QDRO. A
QDRO is a legal document that must be prepared by a lawyer or risks being considered the unlicensed practice of law. Non-lawyers are not subject to malpractice and not bound by attorney-client confidentiality and other ethics rules. Find a specialist to prepare the QDRO if you don’t handle them regularly. There is a huge malpractice risk in this field. An attorney who refers a client to a non-lawyer to handle the QDRO may be subject to malpractice claims if the non-lawyer makes a mistake – even if the lawyer had no involvement with the QDRO.
89
Best Practices
Carolyn A. D'Agostino, Esq.
21 Everett Road Ext. Albany, NY 12205
(518)489-1098
90
Checklist for Separation Agreements:
Attach and Incorporate DRO by reference Be sure that the Plan will permit the contemplated
division before the division is recited in the agreement.
Be sure that ALL retirement assets have been disclosed. − Look for DC companions to DB plans (i.e. Deferred
Comp, Thrift Savings Plan, Union Annuity funds) − Obtain a complete employment history
Review Plan description to determine benefits available – extra enhancements for certain types of employees, extra annuity funds, etc.
91
Checklist, cont'd
Always address in Agreement for any type of Plan: − Who is responsible for preparing the QDRO (and for which
Plan) − Who is responsible for any administrative fees charged by
the plan (can be as high as $400-$500 charged by Plan to qualify the Order)
Address each Plan with specificity and separately in the Agreement − Complete Plan name − IRA account numbers − DO NOT simply say “Husband's retirement benefits” or “Wife
has three IRA accounts” 92
Checklist, cont'd Defined Benefits Plan:
− Method of division: coverture, flat amount, percentage?
− separate/shared interest? − Survivorship − No survivorship for AP: AP's share from
maximum benefit − Disability of Plan Participant? − Cost of Survivorship option?
93
Checklist, cont'd: − Effect of Plan loans − COLAs and other post retirement supplements,
recal for AP if she's commenced benefits − Early retirement subsidies − Code 415 benefit limitations:(high income
pensions), Reductions should be applied proportionately to both parties
− Anti circumvention language − Will retired P pay AP out of pocket until QDRO
filed? − Retroactive assignment dates (be sure Plan will
permit this) 94
Checklist cont'd: Defined Contribution Plans:
− Valuation Date − Division of Benefits (%, $$ amount, etc.) − Investment experience − Effect of loans − Delayed Employer Contributions − Death of AP before segregation, after
segregation − Death of P before/after segregation − Who is responsible for filing QDRO − Who pays administrative fees 95
Client Relations:
− Was client advised of necessity of pension valuation (if client declined, get disclaimer)
− explain deferred distribution vs. immediate offset
− Effect of actuarial reductions − Forfeiture scenarios explained − Disability issues discussed and addressed? − Risk of Delaying QDRO explained
96
Checklist for Pension Discovery:
− Complete employment history. − Breaks in service due to child rearing or disability. − Separate Property Issues − 401k and Cash Balance Plan: value of account as of
date of marriage − Pre-marital service purchased?
Source of funds? − Pre-Marital Loans
For what purpose? Loans paid back with marital funds?
− Benefit Statements 97
Pension Discovery, cont'd: − Prior QDROs: suvivorship option may already be
spoken for − Even if no prior QDROs, prior marriage may mean
possibility of competing spousal rights
98
Request from Plan: Formal name of each plan, name of Plan Administrator and
address to send for QDRO review All plans with that employer in which Employee is a
member Do not assume that the Plan Name on the member's
benefits statement is the “official Plan Name.” www.freeerisa.com : look up plan name, and plan administrator
Dates of membership, participation in the plan, and any breaks in service.
Summary Plan description for each plan to which the employee belongs
QDRO procedures and sample QDROs Benefits statements, projected benefit statements (if
available) or account statements. 99
Plan Authorizations, cont'd: − Vesting provisions of Plan − Loans, encumbrances, withdrawals − Current Beneficiary designations
Beneficiary designation history − look for changes over the years
− Is participant retired? If yes: copy of retirement application, option election,
amount of monthly benefit and where sent, amount of health/life insurance and other deductions. Obtain a copy of spousal waiver (if Plan requires one) potential fraud issue
100
Other Plan information − Benefit enhancements − How will benefit be calculated? Will unused sick leave
or vacation leave affect retirement calculation? − Can member “cash out” of the Plan and receive a lump
sum distribution? Caution spouse on risk of delaying QDRO (even if your retainer doesn't apply to the QDRO)
− Death benefits and Survivorship options − Information for Alternate Payee
Rollover available lump sum segregated account in Alternate Payee's name
− May Alternate Payee direct her own investments? Designate a beneficiary/estate to receive her portion?
101
