The Basics of Pension Plans to Aid in the Preparation of a QDRO
Introduction
Documents
Plans
Contribution Plans
Benefit Plans
Introduction
In matrimonial matters, a party’s pension assets are often the second and in many cases the largest asset for equitable distribution. Yet, these assets are not frequently given much attention within the Property Settlement Agreement (PSA). Proper care needs to be paid to your client’s and/or their former spouse’s pension benefits from the early stages of discovery and not at the time that a Property Settlement Agreement is being negotiated at the Courthouse.
A review of the following information may assist in avoiding common pitfalls related to the negotiation of a party’s pension benefits and the preparation of the Property Settlement Agreement in anticipation of a QDRO.
Documents
A. Determine in the early stages of discovery if any pension benefits exist.
If so, obtain:
1. Most recent benefit statements.
2. A copy of the Summary Plan Description (SPD).
3. Available QDRO Guidelines.
These documents are critical to determine what benefits are available to your client through the Plan. For example, a Plan may not have survivorship benefits, or may only have limited survivorship benefits, in which case you may need to negotiate differently for your client. You do not want to find this out after the Property Settlement Agreement has been entered into and it is too late to negotiate. Further, securing QDRO Guidelines early in the process ensures prompt preparation later on.
Plans
A. Is the Plan a Defined Contribution Plan?
Some examples of this type of plan are:
1. 401(k) or 403(b) Plans
2. Profit-Sharing Plan
3. Employee Savings Plan
4. Employee Stock Ownership Plan
B. Is the Plan a Defined Benefit Plan?
Some examples of this type of plan are:
1. Traditional Pension Plan
2. Annuity Plan (Note, some Plans call their Savings Plan an “Annuity”)
3. Cash Balance Plan
Contribution Plans
A. Defined Contribution Plans
Defined Contribution Plans are somewhat less complicated than Benefit Plans in that there is an identifiable amount of money within an account specifically allocated to the Plan Participant. The value of the account can generally be determined at various dates. The Alternate Payee in most cases has immediate access to the funds without paying early withdrawal penalties, but will pay tax consequences.
B. Division of Defined Contribution Plan
1. Percentage:
Distribution of these accounts by way of a percentage is the most common method. The PSA should state “50% (or 40%) of the account balance from date of marriage (include date) to date of filing of Complaint (include date).”
Advantages: Most equitable method of distribution; most accurate way to account for pre and post-marital assets.
Disadvantages: The distribution amount is not specifically defined in the Order.
2. Straight dollar amount:
A straight dollar amount is often utilized when the fund is being used to offset other assets. The PSA should state the specific dollar amount to be distributed.
Advantages: Provides for an exact distribution amount to a party.
Disadvantages: Depending upon the value of the fund at the time of distribution, can result in an uneven distribution. Some plans may not accept due to fund fluctuation.
C. Other Provisions
1. Gains and losses:
A provision allocating gains and losses to either a percentage or straight dollar amount distribution should be included in the PSA if it is so intended by the parties. The PSA should include language similar to “the Alternate Payee’s allocated amount shall be adjusted for earnings or losses, dividends and interest from date of Complaint (include date) through the date of distribution”. NOTE: If you do not want gains and losses to be included in the distribution you must affirmatively state so in the PSA. New Jersey case law presumes gains and losses are included if they are not excluded.
2. Survivorship:
While not as critical a provision as for Defined Benefit Plans, it is a good idea to include a provision in the PSA that “should the Participant die prior to the establishment of separate accounts, the Alternate Payee shall be treated as the surviving spouse with respect to any death benefits or account balances to the extent of the full amount of the amount herein allocated.”
3. Loan Balances:
If there is a loan against the account, or even if you are not sure whether or not there is a loan, the PSA should address whether or not the loan will be a marital expense or born by the Participant only.
D. Pitfalls to Avoid - Case Studies
Although these plans do not often present with difficulties, there are some re-occurring problems which can be avoided. Plans involving stock ownership can cause difficulty due to fluctuating market values. You cannot rely upon the value of these funds to offset other assets. Also, do not let your client try to predict market values by eliminating gains and losses.
Case: PSA stated that Wife was to receive Husband’s entire 401(k) valued at the time of the marriage at $250,000 plus an additional $178,000 from the Husband’s Savings and Stock Investment Plan (SSIP) as a buy out from the marital home. By the time the QDRO was prepared, the company stock had taken a precipitous drop. Unbeknownst to the attorneys, the Husband’s 401(k) was 60% funded with company stock and the SSIP Plan was funded with 100% stock. The Wife’s distribution turned out to be nearly one half ( ½ ) of what she should have received.
Case: Husbands 403(b) Plan had four years of record gains immediately prior to filing of Complaint. At the time of filing of the Complaint, the fund was valued at $120,000. Property Settlement Agreement was drafted to exclude gains and losses from Wife’s 50% portion of the distribution. When the QDRO was drafted two years later, the fund had experienced a decrease to $90,000. Wife received 50% of value of fund at the time of filing of the Complaint with no adjustment for gains or losses equaling $60,000. Husband was left with $30,000.
Case: Participant was no longer employed with the Plan Sponsor (this is known as a separated employee) and thus, was capable of withdrawing funds. Participant withdraws all funds prior to the QDRO being put in place. Be cautious when dealing with the separated employee situation. You may want to include language in the PSA for curative action including attorney fees should the Participant wrongfully withdraw funds prior to the QDRO distribution.
Benefit Plans
A. Defined Benefit Plans
Defined Benefit Plans are more complicated to divide. The benefit is to be provided to the Participant at some future date upon his or her retirement. The amount of the benefit is based upon a benefit formula set by the plan which usually includes length of service and earnings. The plan funds are held jointly for all Participants and there is no actual account set up for a Participant until retirement. These accounts require pension evaluations to determine their present day value.
B. Shared Interest QDRO vs. Separate Interest QDRO
1. Shared Interest QDRO
A shared interest QDRO is basically a division of the Participant’s annuity payment in a specified amount or percentage between the Participant and the Alternate Payee. Payments begin when the Participant retires, in the form chosen by the Participant, and end at the Participant’s death. If the Alternate Payee predeceases the Participant, the Alternate Payee’s share automatically reverts back to the Participant. In order to ensure continued benefits to the Alternate Payee, the Participant should be required to choose a Qualified Pre-retirement Survivorship Annuity (QPSA) option and a Qualified Joint and Survivorship Annuity (QJSA) option under the Plan. This form of QDRO must be utilized if the Participant is already in pay status prior to a QDRO being put in place. The state and local government Plans (i.e., PERS, TPAF, PFRS) are all shared interest DROs. This form of QDRO favors the Participant. For private plans it should be considered if the Alternate Payee is in poor health or significantly older than the Participant and thus, less likely to live long into retirement. If you intend to use a shared interest QDRO you must use very specific language in the PSA such as “parties agree to a Shared Interest QDRO, based upon the lifetime of the Participant, with a reversionary interest to the Participant”.
2. Shared Interest QDRO
A separate interest QDRO creates two distinct separate accounts for the Participant and the Alternate Payee. Each account is actuarially adjusted for the lifetime of each party. The Alternate Payee may select a commencement date to receive benefits different from the Participant and may chose the form of payment. Once benefit payments begin, they will continue for the lifetime of the Alternate Payee, but will not revert to the Participant upon the death of the Alternate Payee. Cost of living and other increases will not automatically be applied to the Alternate Payee’s share, but must be specifically stated in the QDRO. Also, a QPSA needs to be in place to secure this benefit even with a separate interest QDRO in case of the pre-retirement death of the Participant.
C. Division of Defined Benefit Plan
2. Coverture Approach - Marx Formula:
This is the standard formula used in New Jersey to divide marital assets in a pension. The Alternate Payee is entitled to 50% (or whatever fractional share agreed upon) of the Marital Portion. The Marital Portion is determined by the Plan multiplying the Participant’s final pension benefit by a fraction: the numerator, which is the period of the parties’ marriage during plan participation in months and the denominator, which is the Participant’s total plan participation in months as of the commencement date.
Advantage – Generally this formula favors the Alternate Payee because the fractional share is decreasing over time, it is a smaller share of a larger pension benefit. The Alternate Payee shares in the future growth of the pension benefit.
Disadvantage – the Alternate Payee does not know the value of the benefit until his or her actual retirement. Participant will argue that the Alternate Payee is unjustly enriched by receiving a share of benefits that were not accumulated during the marriage.
CAUTION: If a Plan’s benefits have been frozen and the Participant remains employed with the Plan Sponsor this formula should not be used. The effect will be to reduce the Alternate Payee’s fractional share without any increase in benefits.
2. Immediate Offset Approach:
This formula is still in use by some Plans. The Alternate Payee is entitled to a fractional share of the Marital Portion. To determine the Marital Portion, the Plan multiplies the Participant’s pension benefit as of the marriage termination date by a fraction: the numerator which is the period of the parties’ marriage during plan participation in months and the denominator which is the Participant’s period of employment and plan participation in months as of the marriage termination date.
Advantage – the formula benefits the Participant as the Alternate Payee does not share in any future increases of the pension benefit. The pension benefit is known at the time that the QDRO is put in place. This formula can be used with a pension that has been frozen.
Disadvantage – the Alternate Payee does not share in any future growth of the pension benefit.
D.Survivorship Provisions
1. Qualified Pre-retirement Survivorship Annuity (QPSA):
In a Defined Benefit Plan, the funds are held jointly in a collective account for all the Participants. A Participant’s individual account is not created until he or she retires. Thus, if the Participant does not survive to retirement, an account is not created and the funds remain in the collective account. Basically, the retirement benefit disappears. A QPSA provides that should the Participant die prior to reaching retirement, the named survivor will still receive their share of the pension benefit. A PSA should state that “the Alternate Payee shall be treated as the Participant’s surviving spouse for purposes of receiving a monthly Qualified Pre-Retirement Survivorship Annuity (QPSA) attributable to the Marital Portion of the Participant’s accrued benefit under the Plan”
2. Qualified Joint and Survivorship Annuity (QJSA):
This provision allows the retired Participant to name a survivor to whom a benefit will continue to be paid after the death of the Participant. A pension benefit of a married Participant automatically has a 50% QJSA provision unless waived in writing by the spouse. Shared interest QDROs should require this benefit choice by the Participant. The PSA should state that “at the time of retirement, the Participant shall elect the Alternate Payee as the Participant’s surviving spouse for purposes of a Qualified Joint and Survivorship Annuity (QPSA) attributable to the Marital Portion of the Participant’s accrued benefit under the Plan.” In a separate interest QDRO, this provision is not critical to the continuance of the Alternate Payee’s benefit.
E.Other Provisions
1. Early Retirement Benefits:
These benefits are sometimes provided by a company as an early retirement incentive to older, long time employees. New Jersey case law has held that these incentives are marital property; however, they will not be distributed to an Alternate Payee unless specifically provided for in the QDRO. The PSA should specifically state that “the Alternate Payee is entitled to his or her proportionate share of any employer-provided early retirement subsidy, supplement, incentive and/or cost of living adjustment.”
2. Cost of Living Adjustments:
This benefit is not often found in private Plans; however, to ensure that the Alternate Payee shares in this benefit, it needs to be stated directly in the QDRO. PSA language provided above.
F.Pitfalls to Avoid - Case Studies
Defined Benefit Plans present with an array of options that can cause difficulty in the drafting of the PSA and QDRO. The best defense for avoiding difficulties with these type of plans is to know the plan. Obtain plan documents before entering into a PSA and be specific in your PSA as to the provisions of the QDRO.
Case: Every Plan has it’s own provisions and nuances. Know the Plan. The United Postal Service Pension (UPS) claims that it allows for a Separate Interest QDRO; however, the provisions allowable under the Plan result in a Shared Interest QDRO. In this case, the Wife gave up retention of the marital home for a future benefit in Husband’s pension. The PSA called for “equal division of Husband’s UPS pension with a survivorship interest to Wife”. Unfortunately, the parties were unaware of the nuances in the UPS pension. The UPS Plan requires that the benefit be based upon the lifetime of the Participant and there are limited survivorship options. The only options available are a Ten Year Guarantee or a Husband and Wife Pension where the surviving spouse receives 50% of what they were receiving prior to the Participant’s death. The Husband needs to live a long and healthy life in this case for the Wife to realize a pension benefit equal to half the value of the marital home.
Case: Wife had a significant pension, married to 20 year older Husband. In negotiating the PSA, Husband was given 50% share of the pension with the understanding that Husband’s share would revert to her upon his death. Wife bargained away other assets to “retain” pension. Unfortunately the PSA was not written clearly enough to distinguish a Shared Interest QDRO which resulted in a separate interest QDRO being prepared and Husband receiving separate interest of pension. Wife lost the reversionary interest in 50% of her pension benefit.
Case: The death before QDRO cases. Three recent cases include Husband died in a car accident the weekend after the divorce. Husband died of a heart attack one month after divorce. Husband died of cancer three years after divorce but before a QDRO was prepared. In two of the three cases, Husband’s death resulted in Wife losing pension benefit. In one case, the benefit was saved due to the adequate drafting of the PSA. It is always a good idea to prepare the QDRO pre-judgment and file it at the same time as the Judgment of Divorce to ensure that the benefit does not get lost. If that is not possible, be sure to draft the PSA specific enough that a judge could later rule it satisfied the Plan’s requirements for a QDRO.
The information provided in this guide is by no means exhaustive or all inclusive as it relates to the preparation of Qualified Domestic Relations Orders or the Property Settlement Agreement on behalf of your client. It is intended to provide you with a starting point of reference and a checklist to review. You can always contact our office for additional questions or information regarding the particular pension plan you are dealing with in your case.