Confronted With a Plan that Cannot be Divided by a QDRO? Here’s a Possible Solution

Often the Courts, the Attorneys, and/or the parties to a divorce are dumbfounded when it is assumed, and written into the Settlement Agreement, that a plan is to be divided by a QDRO when, in fact, it cannot be. This often occurs with Municipal Plans not covered under the state retirement systems, such is the case with many Firefighters and Police Officers’ Retirement Systems of various municipalities. The problem lies in the fact that these plans are exempt from the Employee Retirement Income Security Act of 1974 (ERISA) and the Retirement Equity Act of 1984 (REA) under Sections 1003(b)(1) and 1051 of title 29, United States Code, because these plans are “governmental plans” as defined in Section 1001(23) of title 29, United States Code, in which they simply do not have to accept QDRO’s.

Although these plans will accept Income Deduction Orders (IDO), they generally pertain only to child support or alimony, and not property division. The parties then have two options. That is, to either value the plan and offset it against other assets of the marriage, or create a separate order directed not to the plan, but to the parties. Because police and firefighters are considered “protective” employees, they receive normal or full retirement benefits at a much younger age. This fact alone greatly increases the present value of their retirement benefit and makes it nearly impossible to offset the value against other assets.

Therefore, the only alternative is to draft a “QDRO like” order dividing the retirement benefit, whereby the Order forces the parties to establish a non-interest bearing joint account to take receipt of the retirement pay. The reason for this non-interest bearing account is to avoid any complications or tax reporting of interest. The alternate payee’s portion can then be withdrawn, or possibly automatically drafted, from the joint account into the alternate payee’s own account. Preferably, the participant could instruct the plan to make a direct deposit to the joint account. Of course, the Court may apply other alternative methods better suited for the case at hand. With regard to the joint account, both parties could receive statements and share in the cost, if any, of maintaining the joint account.

Other provisions often found in QDRO’s that could be inserted in this particular Order, would be whether or not the alternate payee should be deemed a survivor to a proportionate share of a survivor or death benefits and whether any cost-of-living increases should be awarded. Keep in mind, this type of Order is not a QDRO, nor enforced by the plan(s), but rather it is an Order enforceable on the parties. It is an Order no different than the Settlement Agreement or Final Judgment in terms of enforcability. But again, it is not directed to the pension plan as is the case when awarding benefits under a traditional QDRO. The municipal plans, more than likely, prefer this approach since obviously they do not have to get involved, and there is an advantage to the parties in that several more issues can be addressed or negotiated than could be in an Income Deduction Order or other governmental Orders. Keep in mind that even though police and firefighter retirement plans are used here for illustrative purposes, the QDRO like Order can be applied in any situation where a retirement plan would not accept a QDRO.

With regard to defined benefit municipal plans, paying a monthly pension benefit beginning at a particular retirement age, other provisions can be added or excluded from the Order. For example, language could be included to address other options the participant could select or for which he/she may be eligible. One example is a 30 & Out provision, or any other option or rule which allows a participant to retire upon attaining a certain threshold. The value of the pension increases dramatically since the participant will often receive full retirement benefits at a much earlier age upon completing 25, 30, 35 years of service, depending on the terms and conditions of the plan. This, then results in a larger benefit being paid out over a longer payout period. This is something that should always be considered in QDRO’s, especially in long term marriages and where the participant is close to one of these thresholds. Therefore, the Court may want to consider including such language, depending upon such factors as the length of marriage and length of service. Survivor benefits, both pre-and post retirement, may also be considered assuming the plan would allow for a former spouse to be deemed a beneficiary or survivor. If the plan does not allow a former non-participant spouse to be deemed a survivor, language could be included to name the spouse to a portion of a group term life policy one or the other party may have.

With regard to benefit division, either a percentage, flat dollar amount, fraction, or formula, could be applied in this type of Order. The above describes, and pertains to, a defined benefit pension plan as opposed to a defined contribution plan such as a 401(k).

The municipality may also have a defined contribution plan accompanying the pension plan in the form of a 457(b) plan, similar to a 401(k), except that the participant is not the owner of the account. The employing entity is the actual owner of the “assets” and the account balance is typically not available to the participant spouse until some qualifying event such as termination of employment, death, disability, or upon reaching their earliest retirement age. This too causes a problem since most 457(b) plans do not accept QDRO’s.

Therefore, an Order such as we described in this article could be utilized, or the issues could simply be addressed in the final judgment. Since there is an account balance, and where the value is easily determined as of the date of separation, the division via a Court Order isn’t as complicated. However, if a lump-sum dollar amount is awarded as of a certain date, and assuming that the plan does not accept a QDRO, language should be included possibly awarding interest, dividends, and market value gains and/or losses on the alternate payee’s portion until such a distribution is made. Of course, do not forget about language addressing what should happen to the awarded amounts should one party predecease the other.

Please note that there are some Section 457 plans that will accept a QDRO and where the funds will be set aside for the alternate payee until such qualifying event mentioned above, however, it would be highly unlikely that the alternate payee’s share could be paid out immediately. It is advisable to contact the plan prior to the final divorce to obtain information relating to distributions and QDRO’s.

Again, the type of Order addressed in this article is only meant to accommodate the parties in dividing the retirement benefits equitably and according to the Settlement or Mediation Agreement when other types of Orders are not acceptable. This Order, and Orders of this type have been used successfully and in one Florida Supreme Court case, just handed down recently in McDonald vs. McDonald, the definition of QDRO, and the fact that the municipality did not accept QDRO’s, was at issue. I was involved in this case and explained in a deposition that the term QDRO, as well as the phrase “dividing by QDRO”, is used in a general sense as well as in a specific sense. This, since QDRO’s specifically pertain to private, non-governmental, retirement plans. However, the division of retirement benefits, private or governmental, is often referred to as “… shall be divided by a QDRO”. The Appellate Court agreed that the term QDRO is used generically as well as accepting the “QDRO like” Order to divide the participant’s municipal retirement benefits. The Appellate Court understood the intent was to divide the retirement benefits via a Court Order, QDRO or otherwise.

These issues, as well as these types of Orders, have been utilized in Illinois for some time, since nearly all of the retirement plans in that state, including the state retirement plans, did not accept QDRO’s. However, legislation in Illinois was recently passed forcing municipal plans, as well as their state retirement plans, to accept QDRO like Orders in what is referred to as Qualified Illinois Domestic Relations Orders (QILDRO’s). Although it was hailed as a major legislative milestone, the QILDRO is nothing more than an Income Deduction Order that is deficient in terms of an equitable division for several reasons.

There are no survivor benefits to a former spouse allowed in a QILDRO, in fact the non-participant spouse is disallowed from being elected a survivor or beneficiary. In addition, the QILDRO accepts only a flat dollar amount allowing for no percentages, fractions, and in effect, zero growth in the benefit from the date of division until the date the participant commences benefits, thereby fixing the benefit as of a certain date. Therefore, if the non-participant spouse is several years from retirement, their awarded benefit actually losses value over time simply due to the eroding effects of inflation. For instance, if a participant spouse accrued a monthly retirement benefit of $1,000 per month beginning at their age 65 and the non-participant spouse was awarded 50%, or $500 of the accrued benefit as of the date of separation, and further assuming the parties were both age 45, the value of that same $500 twenty years from now is currently worth $155.90 per month. This while the participant’s benefit increases at an increasing rate every year, since the benefit itself is based on average annual income and total years of service which by the way would include the marital years.

Until further legislation can be passed in Illinois addressing these issues, the new pension laws will be in direct conflict with Family Law Courts which provide for an equitable division. What does the State of Illinois pension laws have to do with your state? The purpose of the Illinois example is to provide some useful insight into the future, since many states are faced with the same dilemma. If the above QUILDRO sounds at all familiar, it should, since many state retirement systems adopted the exact same type of Order. Hopefully, when the legislature of your state gets around to dividing other municipal or governmental plans, they will make the necessary attempts to provide for an equitable division.

Tim Voit is a Financial Analyst and the founder of Voit Econometrics Group, Inc. He has been involved in researching a variety of retirement plans for purposes of divorce while providing expert witness testimony in the valuation of pension benefits in several states. He is also retained in malpractice cases to “fix” QDRO’s and/or to compute and minimize damages for the carrier. Tim and his firm help attorneys and law firms in the drafting of Qualified Domestic Relations Orders (QDRO’s) and other Orders relating to private, governmental, and Military pensions. © Voit Econometrics Group, Inc.