If you’re contemplating divorce, then you should know that any debts acquired during the marriage, such as credit card balances, car loans, and mortgages, must also be divided between the parties. Likewise, assets are subject to an equal and equitable division in the divorce, and that includes retirement benefits.
In general, the wages earned during a marriage are considered to be community property, or marital property. Retirement benefits that are derived from wages earned during the marriage are also considered to be community property, and subject to division in dissolution of marriage. The parties may always negotiate a settlement agreement that provides for a different result. However, in the absence of such an agreement, each party’s deferred employment compensation in the form of a qualified pension, 401k, or IRA, is community property and must be divided between the spouses.
The pension division is accomplished with a Qualified Domestic Relations Order (QDRO). The QDRO is the court’s order which carries out the property settlement of retirement benefits as part of the marital asset distribution in a divorce. The QDRO establishes the non-employee spouse’s right as an “alternate payee” to receive a specific portion of the employee-spouse’s retirement plan (the plan “participant”).
The QDRO orders the retirement plan administrator to distribute a specified percentage of the participant’s benefit to the alternate payee. When both spouses have their own deferred compensation plan, then each plan might be divided. For example, under the QDRO a husband’s pension administrator would be ordered to pay wife a percentage of husband’s pension. Wife’s IRA administrator would be ordered to pay husband a percentage of wife’s IRA. That is, of course, only with regard to the portion of the retirement plans earned, funded, or vested during the marriage — the community property. In the event the pension was completely funded or earned prior to the marriage, then the plan is the separate property of the participant spouse and not subject to division in the divorce.
The plan administrator will not pay a share to the alternate payee without a QDRO signed by the judge. (The exception would be when the plan is non-qualified, such as an annuity, which doesn’t require a QDRO.) The court’s QDRO provides two protections. First, it assures the required payment is made to the alternate payee, preventing the participant from disposing of that share in violation of the divorce decree. Second, the QDRO ensures that each party receiving a portion of the pension is responsible for a corresponding share of the tax liability.
Retirement plans may involve a blend of separate and community property, meaning part of the relevant employment occurred while the plan participant was unmarried and part while married. One commonly applied method of calculating the community property share of the whole pension is as follows: the number of months that the participant was married is divided by the total months the employee-spouse participated in the plan. The resulting percentage is the community property portion of the plan. The community property percentage of the plan is then divided equally between the spouses.
Here’s an example: Husband was married for 25 months, but participated in his retirement plan for a total of 100 months. 25/100 is .25 or 25%. If the plan held $100,000 at the time of the divorce, then the community property portion of that plan would be $25,000 ($100,000 x 25% = $25,000 in community property). The spouses, who have an undivided one-half interest in the community property, would share the $25,000 equally ($25,000/2 = $12,500 for each spouse). The remaining $75,000 in husband’s retirement plan is his separate property because it was earned before the marriage.
The pension plan does not need to be vested for it to be community property. If the participant has a traditional defined benefit plan, then an actuary is used to establish retirement age and life expectancy. If the participant has a profit sharing plan, 401k, or IRA, then the value of the plan is based on its current balance.
The pension plan administrator will not divide the pension between the two parties without the QDRO. Therefore, it is a good idea to get the QDRO drafted early and submit it along with the final decree for the court’s signature. The QDRO may be included in the couple’s property settlement, incorporated into the court’s decree, or issued as a separate order. The decree will establish each party’s interest in each pension, but the QDRO — the court’s order to the administrator — is necessary to carry out the distribution. The order is filed with the pension plan administrators who must comply with the terms of the order when the time to release pension funds begins.
The legal expert who drafts the QDRO really needs to be involved early in the case to have the order prepared and ready when the final decree issues. Attempting to draft your own QDRO is not such a good idea. QDROs are complex instruments and an error can be very costly. A QDRO specialist is recommended because this area of the law is so technical, it really does take considerable legal expertise. The cost of the QDRO may be anywhere from $1,000 to $2,000 or more, depending on the complexity of the family law case. By involving a QDRO expert while the case is pending, the pension division can be fully analyzed and negotiated with a full understanding of the ramifications under the order. Here are two distribution methods that may be negotiated:
Shared Benefit Method — With the shared benefit method, the QDRO requires that the administrator wait until the participant retires before sending the alternate payee his or her share.
Separate Interest Division Method — With the separate interest division method, the alternate payee starts getting his or her share from the participating spouse’s administrator on the earliest possible date for retirement, even if the participant is still working. This method may also require that the alternate payee’s interest terminate if he or she predeceases the participant spouse.
Many employers will provide a sample QDRO to their employees which can be useful as a guide on what the employer expects and wants. The employer’s sample QDRO will likely benefit the employer by making pension administration easier and, consequently, less costly to manage. The employer is not concerned with protecting the rights of the participant and alternate payee under the plan. The QDRO is not a neutral instrument, one spouse or the other will benefit from it.
For more information on QDROs in divorce, visit the U.S. Department of Labor’s FAQs about QDROs