FALL 2015: Drafting Agreement Language for the Division of Retirement Assets (QDROs)

By Michael Foley

Retirement assets can be complex, and having explicit language can assist in avoiding further debate on how a plan is to be divided pursuant to a divorce agreement.  Defined benefit plans, such as pensions, may offer survivor benefits, a shared or separate interest division, and cost-of-living adjustments (COLAs), amongst other components.  There can be confusion in the division of 401(k) plans when the agreement language is silent on whether or not gain/loss is to be included.  We explore here various aspects of retirement asset division to be addressed in separation agreements, so that the process of drafting Qualified Domestic Relations Orders (QDROs) is as straightforward as possible.

Defined Contribution Plans – 401(k), 403(b), 457(b), etc. (Plans with a current cash balance)

The most frequent issues that arise from defined contribution plans are:

  • As of what date is the plan to be divided (“As of” date, end of the marital period)
  • Whether or not gain/loss is to be included
  • How a loan is to be accounted for
  • How a marital portion is to be calculated
  • How an offset will work amongst several plans
  • How fees are to be assessed

“As of” Date

In Massachusetts, the most common scenario is for the date of divorce nisi to be used as the date representing the end of the marital period.  Sometimes, parties will agree upon a different date, possibly the separation date or the date of divorce absolute, or a month-end so that it is easier to obtain the balance as of the agreed-upon date. 

Gain/Loss

Depending on many factors, the QDRO process can sometimes be lengthy, and with a volatile stock market, gain/loss can be significant.  When an “as of” date is specified, our interpretation of the parties’ intent is to simulate as if the transfer took place on that date, and to include the gain/loss from the “as of” date until distribution.  That said, if not explicitly stated in the agreement language, gain/loss can become an incendiary topic. 

Loans

Loans from a 401(k) can be confusing to conceptualize, as the value associated with them has actually been removed from the retirement asset, and embedded into another asset.  For example, one party has a 401(k) with $100,000, and takes out a $10,000 loan for repairs on the marital home.  The value of the 401(k) is now $90,000, and the value of the $10,000 is now embedded in the home.  A 401(k) QDRO cannot assign a loan amount.  The loan can only be paid back from the participant to the participant.  Whenever there is a loan, the simple question is whether the loaned money was used on a marital asset, to be divided accordingly elsewhere, or toward one party’s non-marital benefit.  If the loaned money was used toward a marital asset or marital expense, the 401(k) QDRO should assign the amount excluding the loan amount, as it has already been excluded from the 401(k) plan.  If the loaned amount was to pay for legal fees for one party’s portion of the divorce, the 401(k) QDRO can assign an amount including the loan amount, as if the loan had not taken place.  Note that most plans, but not all, state the current balance as excluding (already reduced by) the balance of the loan.  Carefully read 401(k) account statements to ensure that it is clear whether a loan balance is included or excluded in the total. 

Marital Portion

There are several methods for calculating a marital portion.  The “subtraction method” simply subtracts the balance as of the marriage from the balance as of divorce, and in doing so all of the gain/loss on the premarital portion becomes marital.  By far the most common is the calculation of a “marital coverture fraction,” which in effect equalizes all of the years of participation in the plan, such that if a couple were married for 15 of the 20 years contributing to the plan, the marital coverture fraction would be 15/20, or 75%.  A QDRO could then assign half of the marital portion, or 37.5% to the alternate payee.  A marital coverture fraction is typically defined as the years of participation in the plan during the marriage, over the total years of participation in the plan as of divorce. 

Offsets

Oftentimes, there are several defined contribution plans to be divided.  A QDRO is specific to a particular plan, and so to divide all of the plans, a separate QDRO would be needed for each plan.  Alternatively, many parties agree to use an offset, such that one or two QDROs may be used to effectuate an offset, based on the values of the plans as of a specific date.  An offset implicitly assumes equivalent gain/loss amongst the assets, as the only gain/loss actually applied will be that of the plan(s) for which a QDRO is drafted. 

Fees

When hiring an outside company to draft a QDRO, the fee often also covers receiving preapproval (if applicable), and making any necessary amendments during the preapproval process.  Note that in addition to the fee for drafting a QDRO, many plans have their own administrative fees for processing the QDRO.  It is becoming more common for this processing fee to be passed onto the parties, as the QDRO administrators hired by plans have been more flexible in allowing for the plan to decide whether the plan will pay for this fee, or if the fee will be passed onto the participant and alternate payee.  It is best to be clear in the agreement how any fee for the drafting and/or implementation of the QDRO is to be assigned. 

Summary – Sample Defined Contribution Plan Language

Here is an example working in the above components:

[Note that each plan is different, and this language may not cover every scenario.]

 The marital portions of the defined contribution plans are to be divided equally as of the date of divorce nisi, using the minimum number of QDROs to effectuate this equalization.  Gain/loss is to be included from the date of divorce nisi until distribution.  The marital portions for each plan shall be defined as a fraction, having as a numerator the years of participation in the plan during the marriage up until the date of divorce nisi, and having as a denominator the total years of participation in the plan up until the date of divorce nisi.  Regarding the loan on [Plan X], it is understood the value of the loan is embedded in the value of the [marital home], and so the value of the loan shall be excluded from the value of [Plan X] when calculating the offset.  All fees for drafting and implementation of the QDRO shall be shared equally between the parties. 

Defined Benefit Plans – e.g., private pensions, Mass. State pension, FERS, Military, etc. (Pension Plans that will pay a defined monthly benefit at retirement)

The most frequent issues that arise from defined benefit plans are:

  • As of what date is the benefit to be divided (“As of” date, end of the marital period)
  • Accrued vs. Projected
  • Separate Interest vs. Shared Interest
  • Survivor Benefits
  • COLAs, Early Retirement Subsidies

“As of” Date

Similar to the defined contribution plan divisions as mentioned above, the most common scenario is for the date of divorce nisi to be used as the date representing the end of the marital period.  Sometimes, parties will agree upon a different date, possibly the separation date or the date of divorce absolute. 

Accrued vs. Projected

In Massachusetts, case law has shown that a pension may be divided on an accrued basis (based solely on the benefit accrued as of divorce, though assuming vesting), or on a projected basis (based on the benefit accrued as of retirement) [See Dewan v. Dewan and Brower v. Brower].  The main difference is if the alternate payee will share in increases to the benefit based on salary increases after the divorce.  The accrued method (“Bright Line”) assigns the benefit as of divorce, as if the participant stopped working at divorce, and retired at their actual retirement date (assuming vesting).  The projected method (“Time Rule”) assigns a portion of the benefit accrued as of retirement, which makes for a smaller marital coverture fraction, but the division of a much larger benefit, typically based on salary and years as of retirement.  The accrued method is far more common in Massachusetts, though other states, such as New York and New Hampshire, require the use of a projected basis, referred to as the Majauskas formula and Hodgins formula, respectively. 

Separate Interest vs. Shared Interest

Some plans, such as the Mass. State pension and most governmental plans, only allow for a “Shared Interest” division, meaning the benefit payable will start when the participant retires, and will be based on the lifetime of the participant.  Other plans, such as most private pensions, allow for the alternate payee to receive their benefit as a “Separate Interest” for their own lifetime, after making an actuarial adjustment to make the benefit assigned of equivalent present value.  Typically, any time a pension plan allows for a Separate Interest, both parties prefer to use this method.  The alternate payee can commence benefits as early as the earliest retirement age permitted by the plan (even if the participant continues to work), and it will be payable for the alternate payee’s own lifetime, implicitly preserving a spousal survivor benefit.  The participant then is able to assign a survivor benefit (based on their remaining portion) to a different beneficiary, and allow only the amount assigned to go to the alternate payee.  [One caveat is that any early retirement subsidy provided by the plan may be lost if the alternate payee commences benefits prior to the participant in a Separate Interest.]

Survivor Benefits

There are two basic types of survivor benefits: pre-retirement, covering the period up until retirement, and post-retirement, covering the period after retirement.  For private ERISA plans, the pre-retirement survivor benefit typically assigns the same benefit (e.g., 50%) that would have been assigned at retirement as a separate interest, though plans do allow for the entire pre-retirement survivor benefit (e.g., 100%) to be assigned to the alternate payee.  For governmental plans, the pre-retirement survivor benefit varies, and in cases such as the Mass. State plan, an alternate payee can become ineligible based on either party’s remarriage, even if assigned in the order.  The post-retirement survivor benefit is only applicable to Shared Interest divisions, and bears a cost which reduces the monthly benefit paid out while both parties are alive.  **Survivor benefits are the single, most often omitted component in agreement language.  Allocation of the cost/reduction for any post-retirement survivor benefit needs to be explicitly stated in the agreement language. 

COLAs / Early Retirement Subsidies

Some issues are generally understood as standard, though in rare instances debate can be sparked late in the process if not addressed in the agreement language.  If per the terms of the plan, the total monthly benefit is to be increased each year after retirement by a cost-of-living adjustment (COLA), it is assumed that each party will share this increase on a pro rata basis, although it is best to make this explicit in an agreement.  COLAs are very rare for private plans, but common amongst governmental plans, and often tied to the Consumer Price Index (CPI).  The same logic as above applies to Early Retirement Subsidies, in that they are to be shared pro rata, though they are rare in governmental plans and common in private plans.   

Summary – Sample Defined Benefit Plan Language

Here are examples working in the above components:

[Note that each plan is different, and this language may not cover every scenario.]

[Person One’s] [ERISA Plan (Private) Pension] -

A QDRO shall be drafted to assign 50% of the marital portion of the benefit accrued as of the date of divorce nisi, on a Separate Interest basis to [Person Two].  [Person Two] shall be named as pre-retirement survivor beneficiary for the same amount, and will also be entitled to a pro rata portion of any cost-of-living adjustments (COLAs) or Early Retirement Subsidies.  All fees for drafting and implementation of the QDRO shall be shared equally between the parties. 

[Person One’s] [Massachusetts State Employees’ Retirement System Pension] -

A DRO shall be drafted to assign 50% of the marital portion of the benefit accrued as of the date of divorce nisi to [Person Two].  [Person Two] shall be named as the pre-retirement survivor beneficiary if eligible.  [Person One] shall elect Option C at retirement naming [Person Two] as beneficiary if eligible, with the reduction for Option C shared equally between the parties.  All fees for drafting and implementation of the DRO shall be shared equally between the parties. 

 

[Note, as the Massachusetts state, county, and municipal plans are not “qualified” under ERISA, but rather subject to Massachusetts General Law (Chapter 32), the document is referred to simply as a “DRO.”]

There are many details to the Massachusetts State pension, and complete agreement language covering every scenario can be pages long, examining how exactly the marital portion of a superannuation retirement, accidental and ordinary disability, and a refund of contributions would be calculated, how COLAs are handled, and what happens if the alternate payee becomes ineligible for survivor benefits.  The above serves as a concise basis to ensure the most significant components are addressed initially, though an expert will be able to provide more detailed language to suit your needs.  

IRAs

When dividing an IRA, it is best to ask either a pension expert, or the company holding the IRA for that company’s procedure, as there is a wide divergence of policy.  Fidelity, for example, does not accept QDROs, but requires Letters of Instruction and Acceptance.  Some companies require QDROs, and some only require forms to be filled out.  Also note, when offsetting multiple assets from a pre-tax account such as a 401(k), normal practice is to adjust the present value of a Roth IRA by dividing by .8, to account for the fact that an approximate 20% federal tax has already been deducted.  For example, a $10,000 Traditional IRA would have an equivalent value to an $8,000 Roth IRA after applying the 20% federal tax.

Michael Foley is Vice President of Pension Appraisal Services Associates, a family-owned Massachusetts business since 1986 providing QDRO and pension appraisal services.  Mr. Foley graduated from College of the Holy Cross in 1998, and worked with retirement assets at State Street and Fidelity before joining PASA full-time in 2012.  He has been admitted as an expert witness for pension appraisals, and is an affiliated member of the American Society of Pension Professionals and Actuaries (ASPPA).