Avoiding Qualified Domestic Relations Orders (“QDROs”) Pitfalls
by Kristin Wilkerson
The Employee Retirement Income Security Act, ("ERISA"), codified at 29 USC § 1001 et seq., is a federal law that was enacted in 1974 and provides minimum standards for employer sponsored retirement plans (i.e. 401k, 403(b), profit sharing plans, pension plans, etc.) in the private sector. Today, ERISA covers millions of American workers.[1]
As a general premise, ERISA does not allow an employee participant to assign or alienate the participant's interest in a retirement plan to another person.[2] However, a Qualified Domestic Relations Order ("QDRO") is an exception to the general rule. A QDRO is an ERISA-created term used to summarize the division of retirement plans governed by ERISA. In divorce proceedings, ERISA plans are divisible if a properly drafted QDRO is issued by the district court.
Before diving into some of the pitfalls surrounding QDROs, it is important to understand what types of retirement plans are subject to ERISA and require a QDRO.
Qualified Plans Require a QDRO
In general, there are three (3) basic types of retirement plans: qualified plans, non-qualified plans, and tax advantaged plans. ERISA has limitations and is not applicable to all types of retirement plans. Specifically, ERISA only governs private sector employer sponsored plans. In Wallop v. Wallop, 2004 WY 46, the Wyoming Supreme Court noted "[a] substantial number of State court orders are drafted under the mistaken belief that the Employee Retirement Income Security Act (ERISA) (29 U.S.C. 1001 et seq.) applies to CSRS [Civil Service Retirement System] or FERS [Federal Employees Retirement System] benefits. Sections 1003 (b)(1) and 1051 of title 29, United States Code, exempt CSRS and FERS from ERISA." Paragraph 52. Just as CSRS and FERS are exempted from ERISA, so are individual retirement plan assets such as IRAs.
QDROs, in turn, are only applicable to qualified plans. Qualified plans can be either defined contribution plans or defined benefit plans. Defined contribution plans involve investment risk and contain no guarantee of future benefit. These types of plans include 401(k) plans, 457 deferred compensation plans, and employer sponsored (i.e. SIMPLE or SEP) IRAs. With defined benefit plans, the employer guarantees a benefit and assumes the investment risk. The benefits under defined benefit plans are paid as an annuity based on a formula tied to a plan participant's years of service, final salary and age at retirement. Each qualified plan will be administered by a plan administrator.
Once you have determined that you have a qualified plan that requires a QDRO, ensuring your client's expectations are met requires careful consideration of several factors and careful drafting of the QDRO to meet the plan administrator's requirements.
Considerations Before Entering Final Settlement
As a general rule, ERISA preempts state law as they relate to employee benefit plans.[3] As such, it is important to know whether the plan will allow distributions—especially if some of the retirement funds will be used to generate liquidity.[4] It is crucial when negotiating settlements to find out all the options available to alternate payees before the settlement is final. Keep in mind that every retirement plan you come across, and even among multiple plans of the same employer, may have different requirements for distributions and specific requirements to administer QDROs.
Often clients will want to utilize Internal Revenue Code (IRC) 72(t) as part of the distribution from a qualified plan. This section of the IRC allows an...
