QDRO BLOG | Toxby & Associates

Dividing pensions under a Qualified Domestic Relations Order “QDRO” involves articulating the division of several components of the entire pension benefit; the monthly annuity, COLAs, survivor benefits and early retirement subsides and supplements. Understanding how early retirement subsidies work and their purpose is critical to achieving a fair and complete division of the pension plan under a QDRO.

Participants under a defined benefit pension plan accrue monthly retirement income based on their earnings history and years of service with their employer, using the Plan’s actuarial factors, such as life expectancy. The pension benefit is payable upon the Participant’s attainment of the normal retirement age as defined in the Plan, typically age 65. Most pension plans also have an early retirement age, whereby the Participant may retire at an age prior to the normal retirement age under the Plan, which is commonly once the Participant attains the age of 55, but may be later.

When a Participant retires early, the pension plan is put in a position of paying out monthly pension benefits earlier than the normal retirement age the benefit is based on, and the plan will then actuarially reduce the benefits to reflect this early commencement and that fact that the plan will be paying out benefits for longer than expected. A common reduction is ½ of 1% per month that a benefit commences prior to age 65, for example. If a Participant commences benefit at age 55, under this example, that would be a permanent 60% reduction in the monthly benefits. If a Participant’s age 65 benefit is $1,000 per month and they end up retiring at age 55, the Participant’s benefits is reduced to $400 per month, reflecting this 60% reduction for early commencement (6% a year x 10 years). Early retirement reduction factors will vary from plan to plan.

An employer-provided early retirement subsidy will “add back” the early commencement reduction to a Participant’s monthly pension benefits and will partially or completely eliminate that reduction so that a Participant will receive their age 65 normal retirement benefit even if they are retiring prior to their attainment of age 65. Not all pension plans contain provisions for an early retirement subsidy, and if a Participant continues working and/or does not commence retirement benefits until age 65, then no early retirement subsidy becomes payable from the pension plan.

Early retirement subsidies typically are payable under two situations. 1) to reward long term employees who have met certain age and service credit requirements and 2) to entice an employee to leave the company under corporate downsizing and/or merger and acquisition activity.

Under the first situation, to reward longer term employees, the Plan may have a “Rule of 85” or “Rule of 90” provision whereby an employee whose age and service years combine to reach 85 or 90, will qualify for an early retirement subsidy and may retire will full pension benefits. For example, an employee who is age 60 and has 25 years of service will have reached the Rule of 85, and therefore be eligible for an unreduced pension benefit. The age and service year requirements will vary from Plan to Plan to be eligible for an early retirement subsidy. The subsidy in this respect is solely due to length of service by the employee and not due to pension increases, salary increases, Plan enhancements or ad hoc increases made to the pension plan.

The second situation is where a company is downsizing employment based on economic conditions or laying off employees due to a merger/acquisition. The cost of maintaining an employee is vastly greater than the cost to subsidize a pension benefit to entice an employee to separate service, and therefore some companies will offer a “buyout” to their employees which can contain a provision for an early retirement subsidy. The subsidy works the same in that it adds back the early retirement commencement reduction, and may not be offered to all employees. If an employee was already retirement eligible (i.e. age 55 or older), the employer may grant an early retirement subsidy from the pension for that person, and if an employee was not yet of retirement age (i.e. age 48) then no subsidy would be offered to that employee. This type of early retirement subsidy is based on the company’s economic status and is not based on length or service or other metric. It is simply an enticement to get an employee to leave the employer, which results in cost savings for the employer.

I include early retirement subsidy language in just about all of my pension QDROs. They are part and parcel of the pension benefit, just like cost of living adjustments, and you could have an inequitable division if they are not included. Working with an assumed 75%/25% division of a $1,000 per month age 65 benefit and the 60% reduction factor above, The Participant receives $750 (75%) of that and the Alternate Payee $250 (25%). If the Alternate Payee commences at age 55 and has a 60% permanent reduction in their benefit due to early retirement (no early retirement subsidy provisions in the QDRO), the Alternate Payee would receive $100 a month for life under the 60% reduction factor at age 55. The Participant, who does qualify for an early retirement subsidy by virtue of his employment, receives the full $750 at age 55 for life. So instead of a 75/25 division, you have one party receiving the full 75% and the other 10% of the monthly benefit because no early retirement subsidy was applied to the 25% share. It is also important to note that the subsidy that would be applicable to the Alternate Payee’s share, does not get paid to the Participant, and that subsidy is kept by the pension plan, so it is a benefit that then gets paid to nobody.

Given the possibility for an inequitable division, and that a “lost” early retirement subsidy does not get paid to anyone, is why early retirement subsidy language goes into my pension QDROs by default.

Thomas Toxby

Drafting the appropriate provisions for dividing retirement plans within the Separation Agreement is a critical task that will avoid any post-decree issues relating the terms of the retirement plan division and will enable the subsequent Qualified Domestic Relations Order (“QDRO”) or other division order to be properly prepared within the terms of the parties’ agreement. Given that there are many different types of retirement plans with unique characteristics, benefit options, survivorship considerations and distribution choices, understanding the type of retirement plan you may be dealing with, and fully articulating the division within the Separation Agreement is essential.

Perhaps the most common type of retirement plan encountered is the Defined Contribution Plan. These types of plans include 401(k), IRA, 403(b), 401(a) Profit Sharing Plans and 457 Deferred Compensation Plans. These plans will have daily values that can fluctuate greatly due to stock market movements and may have loans against the account which can diminish the divisible value.

Below is a checklist for the specifics you should address when drafting Separation Agreement provisions for a Defined Contribution Plan:

·        Valuation Date. This is the date the Plan will be directed to value the retirement account for the purposes of division and to exclude any employee and employer contributions made to the Plan subsequent to that date, and should be specifically referenced within the Separation Agreement. Most cases will call for the valuation date to be the date of the decree, but it could be a prior date that the parties have agreed to or a date that multiple retirement plans would be offset against each other or could be a future date if trying to award a flat dollar amount for the Former Spouse/Alternate Payee (i.e. $10,000 valued as of the date of account segregation by the QDRO)

·        Pre-Marital Account Balances. Any reductions to the Plan to account for any pre-martial account balance should be listed in the Separation Agreement. A vast majority of Defined Contribution Plans will not accept a QDRO that directs the Plan to deduct an account balance as of a specific historical date, such as the day prior to the marriage. This could be 20 years in the past and the Plan may not even have records going back that far or may have switched Plan record keepers which would make obtaining this value impossible. Therefore, if there are any pre-martial amounts that need to be taken off the QDRO award, this specific dollar amount should be obtained by the Plan Participant and put in the Separation Agreement. That way the QDRO can be properly drafted to direct the Plan to take the total account balance, reduce it by the specific dollar amount representing the pre-martial portion, and then divide the account 50/50 or otherwise.

·        Investment Experience.  Will the assigned amount be adjusted from the valuation date for earnings, interest, gains and losses until it is transferred into the Former Spouse’s name? When dividing a retirement plan for martial property purposes, the assigned amount would typically be adjusted for investment experience. When assigning an amount for martial debt payoffs, exchange of other items of martial property (i.e. home equity) or for a lump sum spousal support payment, the assigned amount should typically be a flat dollar award and thus should not be adjusted for investment experience and should be valued as of the date of account segregation.

·        Loan Treatment. Is there an outstanding loan on the account and how should it be accounted for? Loans will reduce the divisible value of the Defined Contribution Plan and can cause problems when attempting to assign a specific dollar amount or when awarding 100% of an account to a Former Spouse. If the original loan was used for marital purposes, it may be proper to have the total account balance reduced by the amount of the loan, so that both parties share in the “cost” of the loan, and then to have the “net” account balance divided. Conversely, if the loan was for an individual purpose for the account holder, it wouldn’t be fair to “penalize” the Former Spouse for this and therefore the loan balance should be added back to the total account balance when calculating the Former Spouse’s share of the Plan.

·        Correct Name of the Plan. The Separation Agreement should contain the full name of the Plan for identification purposes. Merely referencing a “401(k) Plan” can be vague, especially if there are multiple retirement plans that are sponsored by one employer. Lockheed Martin, Ball Corporation and other large employers may sponsor 3 or 4 or more different 401(k) Plans depending of the employee’s status within the company. The employer’s name and full Plan title should be listed. (i.e. Ball Corporation Salary Conversion and Employee Stock Ownership Plan) 

·        Survivorship. There should be a provision that states the death of the account holder shall not affect the Former Spouse’s assigned amount. (i.e. In the event the Plan Participant predeceases the former spouse, such Participant’s death shall not affect the assigned benefits to the Former Spouse under this Agreement and the subsequent QDRO. To the extent required to secure the Former Spouse’s interest in the Plan, the Former Spouse shall be considered as the Surviving Spouse of the Participant under the Plan to the extent of their assigned interest as agreed to herein.)

·        Actions by the Plan Participant. The Participant can thwart the division process by engaging in withdrawals, rollovers, loans and other actions that can diminish the value of the account and/or complicate the QDRO process from the time the Separation Agreement is signed through the time that the account is actually divided by a QDRO. Having a protective provision within the Agreement that bars any such actions and makes the Plan Participant accountable for any such actions is advisable.

·        Waiver of Interest in Plan and Change of Beneficiary. In the event a retirement plan is not being divided and is being retained by the Plan Participant as their sole and separate property, a provision requiring the Plan Participant to change beneficiary designations shortly after the divorce is advisable in light of the recent Supreme Court decision regarding the DuPont Profit Sharing Plan. (i.e. The Participant shall have 10 days from the date of the decree to contact his/her retirement plan administrator and change their beneficiary designations under the Plan on the proper form as provided by the Plan.)

            Thomas H. Toxby

Hello, I am Thomas Toxby, President of Toxby & Associates, Inc. and QDROspecialist.com. I specialize in providing retirement plan expertise to the divorce process and the drafting of Qualified Domestic Relations Orders (“QDRO”) and other division orders for federal, military and state-sponsored retirement plans. Please note that I am not an attorney, nor is anyone on my staff, and I cannot provide you any legal advice whatsoever. However, I am a retirement plan expert and can speak with years of experience as to the mechanics of retirement plans, tax issues, investment and benefit options and the QDRO process.

Prior to starting this company, I was a Plan Administrator at TIAA-CREF, and I assisted attorneys, participants and alternate payees with drafting, editing and preparing QDROs to be in compliance with over 15,000 retirement plans held at the company. We handled a volume of about 3,600 QDROs annually, targeting a myriad of retirement  plans from tax-sheltered annuities, 401(a)s and 401(k)s, 457 deferred compensation plans, IRAs and 403(b) Plans.

I have been a financial/investment advisor and retirement plan expert my entire career, having worked at Morgan Stanley Dean Witter as an investment advisor, as a fee-based money manager and has a financial editor for Infobeat/Exactis. I saw a need for a retirement plan expert to draft QDROs for divorcing couples, as attorneys are legal experts, but not necessarily retirement plan experts; and most Family Law attorneys will be the first one to tell you this. A bulk of my QDRO work comes through the referrals from my attorney clients and I also work with individuals who may have found me via my website on the internet.

I receive a number of questions on a daily basis from folks who have found me on the internet, with all types of QDRO situations ranging from the ordinary to the very rare, and I decided to start this Blog as a way to share my knowledge and experience. I encourage you to contact me with any questions related to QDRO services or any issues you may like discussed on this Blog.

I will also be posting articles and commentary on the QDRO process, the impact of changes in the law regarding retirement plans and QDROs, and some of the unique situations I have dealt with. So please do check back here often for updates and e-mail me with any questions you may like answered here.

Thomas H. Toxby