Under IRC §414(p)(1)(B) of the IRC and §206(d)(3) of ERISA, a domestic relations order is a judgment, decree, or order, including approval of a property settlement agreement, relating to child support, alimony, or the marital property rights of a spouse, former spouse, child, or other dependent of the participant.[1] Further, the order must be made pursuant to the domestic relations law (including community property law) of a state.[2]
IRC §414(p) only applies to plans subject to the anti-alienation rule of IRC §401(a)(13). Therefore, §414(p) does not apply to IRAs, and it is inappropriate to refer to a domestic relations order affecting an IRA as a QDRO. Rather, the taxation of an IRA divided in a divorce is governed by IRC §408(6), where the entire problem (in contrast to §414(p)) is handled adequately in two sentences.
A qualified domestic relations order (QDRO) is a domestic relations order which creates or recognizes the existence of right of an alternate payee,[3] or assigns to an alternate payee the right, to receive all or a portion of the benefits payable with respect to a participant under a plan,[4] and which, in addition, meets the requirements of IRC §414(p)(2) and (3).[5]
Under IRC §414(p)(2), the Order must clearly specify a number of matters.
The Order must clearly specify the name and last known mailing address (if any) of the participant and the name and mailing address of each alternate payee covered by the order.[6] (Note, however, that the committee reports of the Senate Finance Committee state that an order will not be treated as failing to be qualified merely because the order does not specify the current mailing address of the participant and alternate payee if the plan administrator has reason to know that address independently.)
The Order must clearly specify the amount or percentage of the participant's benefits to be paid by the plan to each such alternate payee, or the manner in which such amount or percentage is to be determined.[7]
The Order must clearly specify the number of payments or period for which payments are required.[8]
The Order must clearly specify each plan to which the order applies.[9]
Under IRC §414(p)(3), the order must not contain certain provisions.
The order must not contain any provision that requires the plan to provide any type or form of benefit, or any option not otherwise provided under the plan.[10]
The order must not contain any provision that requires the plan to provide increased benefits (determined on the basis of actuarial value).[11]
The order must not contain any provision that requires payment of benefits to an alternate payee that are required to be paid to another alternate payee under a previous existing QDRO.[12]
IRC §414(p)(4)(A) provides that a domestic relations order will not be treated as failing to meet the requirements of 414(p)(3)(A) (which disqualify an order requiring a plan to provide a type or form of benefit, or option, not otherwise provided under the plan) solely because such order requires that payment be made to an alternate payee--
(i) before a participant has separated from service on or after the date on which the participant attains (or would have attained) the earliest retirement age,
(ii) as if the participant had retired on the date on which such payment is to begin under the order (but taking into account only the present value of the benefits actually accrued and not taking into account the present value of any employer subsidy for early retirement), and
(iii) in any form in which such benefits may be paid under the plan to the participant (other than in the form of a joint and survivor annuity with respect to the alternate payee and his or her spouse).
(For purposes of clause (ii), the interest rate assumption used in
determining the present value shall be the interest rate specified in the plan
or, if no rate is specified, 5%.)
§414(p)(4)(B) as amended by TRA '86, provides that the term earliest retirement age means the earlier of--
“(i) the date on which the participant is entitled to a distribution under the plan, or
“(ii) the later of
“(I) the date the participant attains age 50, or
“(II) the earliest date on which the participant could begin receiving benefits under the plan if the participant separated from service.”
It would appear that because of IRC §414(p)(3)(A), as modified by IRC §414(p)(4), a domestic relations order cannot require a plan to make a distribution to an alternate payee at a time earlier than the plan could make a distribution to the participant, unless the participant has reached the earliest retirement age under the plan. All pension plans and most profit sharing plans prohibit a distribution before the participant has reached normal retirement age or separated from service.[13]
In summary, it will generally be the rule that no domestic relations order will be valid as a QDRO if it requires a distribution before the participant has either:
(1) attained age 50, or
(2) separated from service,
unless the plan is a profit sharing plan that allows for in-service withdrawals on demand, after a specified number of years, in accordance with the principals of Rev. Rul. 68-24.
However, despite the foregoing, if the plan specifically provides for a distribution pursuant to an otherwise qualified domestic relations order, then the distribution can be made without violating the terms of the plan and this should cure the problem. Can a plan contain such a provision? See below.
The Conference Report to the bill states that a plan may provide for payments to the alternate payee prior to the participant's earliest retirement age. Conf. Rep. p. II-858. Exactly what was intended by this statement is not clear, but it may be that the Plan could be drafted so as to provide for a distribution to an alternate payee at any time. Consistent with the Conference Report, the final QDRO regulations indicate that the plan may specifically provide for payments to an alternate payee under a QDRO prior to the earliest retirement age.[14]
According to the Committee Reports, the plan will become disqualified if it makes a distribution under a domestic relations order that is not a QDRO.
Further, it is likely that the participant, rather than the payee spouse, will be taxed on the distribution to the payee spouse if the order is not a QDRO.[15]
Under IRC §414(p)(6)(B) all qualified plans are required to establish reasonable procedures to determine the qualified status of domestic relations orders and to administer distributions under such qualified orders. Most plans will have a statement that such procedures are to be established, but the procedures themselves will usually not be found in the Plan. Therefore, it will be necessary for such procedures to be adopted.
IRC §414(p)(6)(A) requires that the Plan Administrator give certain notices when a domestic relations order is received. Specifically, the Plan Administrator is to (1) promptly notify the participant and any other alternate payee of the receipt of a domestic relations order, (2) notify them of the Plan's procedures for determining the qualified status of domestic relations orders, and (3) within a reasonable period after receipt of the order, determine whether the order is a qualified domestic relations order and notify the participant and each alternate payee of such determination.
The Employee Benefits Handbook, Jeffrey Mamorsky, Editor, published by Warren, Gorham & Lamont, 1987, contains in Chapter 28 a good discussion of the legal requirements of a QDRO. The appendix to this chapter contains some suggested procedures to be adopted by a plan and two sample notification letters designed to comply with IRC §414(p)(6) and (7).
The QDRO should indicate whether or not the former spouse will be entitled to benefits at the participant's death. If the plan provides a forfeiture at death, the nonparticipant divorced spouse could be left with nothing. If the participant remarries, the new spouse could be entitled to the Qualified Preretirement Survivor Annuity (QPSA), unless the QDRO treats the former spouse as a surviving spouse of the participant for purposes of the Survivor Annuity rules. IRC §414(p)(5) specifically allows the QDRO to contain such a provision.[16]
(The QDRO should also indicate whether or not the beneficiaries of the alternate payee will be entitled to benefits in the event the alternate payee dies prior to the complete distribution of his or her interest.)
In William E. Dugan, et al. v. Lillian Clinton, et al., USDCt, N. Dist. Ill., Eastern Div, No. 86 C 8492, May 22, 1987, a QDRO left the nonparticipant spouse 25% of the participant spouse's benefit. The participant remarried and died prior to early retirement age. Apparently the only benefit payable on death was the QPSA, which belonged to the new spouse. Therefore, the new spouse got the QPSA and the prior spouse received nothing. The Dugan case is reported in CCH New Developments at ¶23,735, and is reported in PPD Current Developments at ¶323.09 (9/87). My reading of the new Treasury Regulations is that they are not consistent with the Dugan case. See Treas. Reg. §1.401(a)-13(g).
A QDRO ordinarily ought to provide that the alternate payee spouse will be treated as a surviving spouse, to the extent of his interest, for purposes of the QPSA.[17]
See the discussion by Congressman Clay of Missouri, in the Congressional Record of August 9, 1984, for four examples of how the survivor annuity rules will interact with a QDRO. These examples are reproduced in the CCH Pension Plan Guide at ¶2547I.
It is not permissible in a defined benefit plan to express the benefit to be paid under the QDRO as a single sum dollar amount, unless the plan gives the participant the absolute and unqualified right to receive his benefit in lump sum. Assuming, however, that the plan does give the participant this right, such a provision would be permitted.
This is probably true, even though fiduciary consent to a lump sum distribution election is required, although arguably, an order could fail if it directs the trustee to make a distribution in a form that the trustee, through the exercise of discretion, could not be forced to make. Since the regulations to §411(d)(6)[18] no longer permit trustee discretion as to the form of benefits, except in unusual situations, this problem may now be largely moot.
The Order may contemplate that a dollar figure will be set aside and accounted for separately. This is permissible.
§414(p)(7)(A) and (B), as amended by the 1986 Tax Reform Act, now provides:
"(A) IN GENERAL. -- During any period in which the issue of whether a domestic relations order is a qualified domestic relations order is being determined (by the plan administrator, by a court of competent jurisdiction, or otherwise), the plan administrator shall separately account for the amounts (hereinafter in the paragraph referred to as the "segregated amounts") which would have been payable to the alternate payee during such period if the order had been determined to be a qualified domestic relations order.
"(B) PAYMENT TO ALTERNATE PAYEE IF ORDER DETERMINED TO BE QUALIFIED DOMESTIC RELATIONS ORDER. -- If within the 18-month period described in subparagraph (E) the order (or modification thereof) is determined to be a qualified domestic relations order, the plan administrator shall pay the segregated amounts (including any interest thereon) to the person or persons entitled thereto."
Therefore, an order will not be disqualified merely because it requires that the benefit be accounted for separately and credited with interest. If the plan does allow for lump sum payments at the participant's election, and if the Participant has reached the earliest retirement age under the plan, then the law requires that the plan keep a separate accounting on the benefit, and if, during the 18 month period following receipt of notification of the existence of the order, it determines that the order is qualified, interest on the benefit, if applicable, may be paid.
How the "interest" is to be computed is not clear from the statute. I had a discussion with Stuart Siskind, an official in the National Office of the IRS who is involved in the promulgation of regulations in this area, and he indicated to me that the "interest" factor was meant to refer to whatever method the plan would otherwise use to credit a suspended distribution.
Also unclear under the statute is whether or not a benefit expressed as a dollar amount may be physically segregated, such that the alternate payee will be entitled to experienced gains and losses, rather than "interest." Without any regulations as guidance, I would have to believe the Blue Book,[19] which states that if the Plan Administrator defers payment under an order during the reasonable period of time it takes to determine whether or not the order is qualified, then the deferred benefits are to be "segregated either in a separate account in the plan or in an escrow account." The Blue Book notes that the "Act eliminates the requirement that a defined benefit plan establish an escrow account for amounts that would have otherwise been paid during the 18-month period. Instead, the plan administrator is required only to account separately for such amounts." It might be the case that in order to have physical segregation, the plan would have to allow for it, and if instead, interest is to be paid, the plan would have to allow for that also. Again, we have no regulations to offer guidance.
If interest is to be credited, my best guess is that the plan rate should be used. If the assets are instead physically segregated, it may be permissible to credit the deferred benefit with actual gains or losses.
It should also be noted that if it is possible, but not certain, that the Order will require payment of a benefit in excess of the participant's vested accrued benefit, the Order will fail as a QDRO.[20] One suggested approach would be to include a provision under which the amount of benefits payable to the alternate payee is not to be in excess of the participant's vested accrued benefit as of the date payments are to commence to the alternate payee.
The QDRO should indicate whether or not the alternate payee will be entitled to benefits at the participant's death, assuming this is permissible in a QDRO (see below.
The QDRO should indicate whether or not the beneficiaries of the alternate payee will be entitled to benefits in the event the alternate payee dies prior to the complete distribution of his or her interest.
In most cases, a QDRO should provide that the alternate payee will be treated as a surviving spouse, to the extent of his interest, for purposes of the QPSA and QJSA.[21]
It is generally advisable to include a provision that the benefits payable to the alternate payee will not be in excess of the participant's vested accrued benefit as of the date payments are to commence to the alternate payee.
ERISA §206(d)(3)(J), provides—
A person who is an alterate payee under a qualified domestic relations order shall be considered for purposes of any provision of this Act a beneficiary under the plan.[22]
Can a plan pay the alternate payee’s benefit to someone who is not the alternate payee? Presumably not, at least during the alternate payee’s lifetime; but what if the alternate payee has died?
The term “alternate payee” is defined in 414(p)(8) as meaning—
any spouse, former spouse, child or other dependent of a participant who is recognized by a domestic relations order as having a right to receive all, or a portion of, the benefits payable under a plan with respect to such participant.[23]
I have not researched this issue, but have been told by those who have, that there is no clear authority for paying an alternate payee’s benefit to anyone other than the alternate payee, even after death. I suspect that a lifetime assignment might be somewhat problematic. One must surely assume that the statute was not intended to work a forfeiture at death.
Could it not be reasonably argued that a payment to the estate of the alternate payee is the functional equivalent of payment to the alternate payee? One can only hope so. Nevertheless, there is definitely a need for regulatory guidance on this point.
In the Appendex to Notice 97-11[24] the IRS appears to recognize that a QDRO can provide for what happens to the alterate payee’s benefits at death:
QDRO drafters should also consider how the benefits divided under the QDRO may be affected, under the plan, by the death of either the participant or the alternate payee.[25]
An alternate payee under a QDRO who is or was a spouse will ordinarily pay tax on the distribution under rules otherwise applicable to recipients of qualified plan distributions. Income taxation may be postponed, however, if the QDRO benefits are rolled over.
(A) Alternate payee treated as distributee. For purposes of subsection (a) and section 72, an alternate payee who is the spouse or former spouse of the participant shall be treated as the distributee of any distribution or payment made to the alternate payee under a qualified domestic relations order (as defined in section 414(p)).[26]
In Karem v. Commissioner, the Tax Court held that when a participant paid his former wife a portion of his benefits under a qualified plan, pursuant to a divorce decree that was not a QDRO, the husband was taxed on the distribution, not the wife, despite the fact that the proceeds were community property prior to the divorce.[27] §402(g)(6), like §408(g), states that the distribution taxation rules are to be applied “without regard to community property laws.” Here, the section was literally applied.[28]
The Karem case did have some unique facts. For example, the lump sum distribution took place in a year prior to the entry of the consent judgment ordering the division of the plan proceeds. It does not appear, however, that this fact was deemed significant. The taxpayer’s alternative argument, which was unsuccessful, was that half of the proceeds were community property, and therefore taxable one-half to each spouse, regardless of the qualified status of the court order.
But see Rodney Powell, et. al. v. Commissioner, 101 T.C. 32 (1993), for an opinion that appears to be contrary to Karem .
The Service has privately ruled that under Lucas v. Earl,[29] the seminal assignment of income case, the participant in a nonqualified plan will be taxed on distributions to a spouse made pursuant to a divorce decree.[30] (The QDRO rules of IRC §414(p) do not apply to nonqualified plans.)
A QDRO payee[31] (unlike a surviving spouse) may rollover to any eligible retirement plan, including another qualified plan.[32]
Ordinarily, a distribution from a qualified plan or IRA prior to the date a participant turns 591/2 is subject to a 10% excise tax. However, IRC §72(t)(2)(D) makes an exception in the case of a distribution to an alternate payee under a QDRO.
Note, however, that IRAs (including SEP-IRAs) are not subject to QDROs.[33] Pursuant to IRC §408(d)(6) an IRA may be transferred to a spouse without recognition of income tax, but the order effecting the transfer is not a QDRO, and therefore, if the proceeds are withdrawn before the spouse is 591/2, the early withdrawal tax will ordinarily apply.
The DOL apparently does not believe that expenses associated in connection with the administration and interpretation of a QDRO may be charged against the individual account of the affected participant.[34]
Note that IRAs (including SEP-IRAs) are not subject to QDROs because the anti-alienation rule of IRC §401(a)(13) does not apply to them.[35] IRC §408(d)(6) is the Code Section to consult with respect to the division of IRAs on divorce. §408(d)(6) provides that if a transfer of an individual’s interest in an IRA to a spouse or former spouse under a divorce or separation instrument described in IRC §71(b)(2)(A) the transfer will not be treated as a taxable transfer, and the interest at the time of transfer will be treated as an IRA of the transferee spouse.
Where a couple in a community property state divided the husband’s IRA under a private separation agreement, the IRS privately ruled that the husband was taxable on the transfer and that §408(d)(6) did not apply.[36]
The 1993 IRS Publication 590 details three ways that IRAs may be divided in a divorce settlement.[37]
[1]IRC §414(p)(1)(B)(i). ERISA §206(d)(3)(B)(i).
[2]IRC §414(p)(1)(B)(ii).
[3]Under IRC §414(p)(8) an alternate payee includes a spouse, former spouse, child, or other dependent of a participant who is recognized by a domestic relations order as having a right to receive some or all of the benefit payable with respect to a participant.
[4]IRC §414(p)(1)(A)(i).
[5]IRC §414(p)(1)(A)(ii).
[6]IRC §414(p)(2)(A).
[7]IRC §414(p)(2)(B).
[8]IRC §414(p)(2)(C).
[9]IRC §414(p)(2)(D).
[10]IRC §414(p)(3)(A).
[11]IRC §414(p)(3)(B).
[12]IRC §414(p)(3)(C).
[13]Treas. Reg. §1.401-1(b)(1)(i). But see Rev. Rul. 68-24, Rev. Rul. 71-295, Rev. Rul. 71-446 and IRS Pub. 778 (2-72) Part 2 (c).
[14]Treas. Reg. §1.401(a)-13(g)(3).
[15]Robert L. Karem and Hazel W. Karem v. Commissioner, 100 T.C. No. 34 (CCH Dec. 49,091) (1993).
[16]See also 1.401(a)-20, A-25(b) and §1.401(a)-13(g)(4).
[17]IRC §414(p)(5).
[18]Treas. Reg. §1.411(d)-4.
[19]Explanation of the Technical Corrections Provisions of the 1986 Tax Reform Act prepared by the Staff of the Joint Committee on Taxation, released May 15, 1987.
[20]IRC §414(p)(3)(B) and ERISA §206(d)(3)(D)(ii).
[21]IRC §414(p)(5). William E. Dugan, et al. v. Lillian Clinton, et al., USDCt, N. Dist. Ill., Eastern Div, No. 86 C 8492, May 22, 1987; discussion by Congressman Clay of Missouri, in the Congressional Record of August 9, 1984, CCH Pension Plan Guide at ¶2547I; contra?, Treas. Reg. §1.401(a)-13(g).
[22]ERISA §206(d)(3)(J).
[23]IRC §414(p)(8).
[24]Notice 97-11, 1997-2 IRB.
[25]Notice 97-11, 1997-2 IRB, C.1.
[26]IRC §402(e)(1)(A).
[27]Robert L. Karem and Hazel W. Karem v. Commissioner, 100 T.C. No. 34 (CCH Dec. 49,091) (1993). Cf., Darby v. Commissioner, 97 T.C. 51 (1991).
[28]Contrast this literal application of the statute with PLR 8040101.
[29]Lucas v. Earl, 281 U.S. 111 (1930).
[30]PLR 9340032.
[31]That is, the alternate beneficiary under a qualified domestic relations order described in IRC §414(p).
[32]Temp. Treas. Reg. §1.402(c)-2T Q&A-10.
[33]IRC §414(p).
[34]PWBA Opinion Letter 94-32A. See CCH Pension Plan Guide ¶23,898D.
[35]IRC §414(p)(9).
[36]PLR 9344027.
[37]For a comment on the three ways of transferring an IRA on divorce, see CCH Pension Plan Guide ¶26,500.