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December 2003 Newsletter
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| Below you will find highlights from our most recent
newsletter. Feel free to download the PDF to print a version for
yourself. |
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In this issue these are the topics discussed:
- Introduction
- Qualified Domestic Relations Orders
- Valid QDRO Determination
- Plan Administrator QDRO Duties
- Access to Plan Information
- When Benefits Can Start
- Division of Benefits
- Defined Benefit Plans
- Defined Contribution Plans
- Tax Treatment
- Modifying QDRO Benefits
- Allocating QDRO Expenses
- Conclusion
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Introduction
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The benefits accumulated under
qualified pension and profit sharing plans are often one of the
largest assets a married couple owns. If the couple divorces,
sometimes their retirement benefits must be divided. Since 1984,
federal pension law has provided special procedures enabling
family courts to divide pensions in a divorce or separation.
Although the rules governing the division of retirement plan
benefits in a divorce are straightforward, strict compliance
with applicable legal requirements is necessary to avoid
possible plan disqualification or the taxation of benefits to
the participant rather than the one receiving the benefits.
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Qualified Domestic Relations Orders
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| Pension law authorizes qualified
retirement plans to comply with state court domestic relations
orders dividing pension benefits, whether by separate court
order or a court-approved property settlement agreement.
However, the order must satisfy certain requirements in order to
be considered a "qualified" domestic relations order (QDRO).
Generally, a domestic relations order is used to provide
child support or alimony payments, or to divide marital property
as part of a divorce. The QDRO creates or recognizes a right of
an alternate payee to receive all or a portion of the benefits
payable to a plan participant. The alternate payee is usually
the spouse or former spouse but can also be a child or other
dependent of the participant.
Plans are required to have written reasonable procedures for
determining whether domestic relations orders are QDROs and for
administering distributions. The procedures should be designed
to ensure that QDRO determinations are made in a timely,
efficient and cost-effective manner, consistent with the
administrator's fiduciary duties under ERISA.
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Valid QDRO Determination
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| The plan administrator is responsible
for determining whether an order is a QDRO. However, it is not
the plan administrator's task to evaluate the fairness of the
QDRO but only to determine that the order meets the legal
requirements to be a valid QDRO.
To be a valid QDRO, the order must be sent to the plan
administrator and clearly specify the following required
information:
- The name and last known mailing address of both the
participant and each alternate payee covered by the order;
- The amount or percentage of the participant's benefits to
be paid to the alternate payee (or the manner in which the
amount or percentage is to be determined);
- The number of payments or period to which the order
applies; and
- The name of each plan to which the order relates.
A domestic relations order is not a QDRO if:
- It requires the plan to provide an alternate payee with
any type or form of benefit not otherwise provided by the
plan;
- It requires the plan to provide for increased benefits; or
- It requires the plan to pay benefits that are already
required to be paid to another alternate payee under a prior
QDRO.
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Plan Administrator QDRO Duties
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In most cases, the employer is the plan administrator. The
employer may be the plan administrator as a corporate entity, if
it is a corporation, or as a partnership, if that is its
business structure. Or, the plan administrator may be a named
individual or a committee appointed by the employer.
The plan administrator is required to promptly notify both
the participant and alternate payee of receipt of the order and
to provide to them a copy of the plan's written procedures for
determining whether the order is a QDRO.
During the review process, the plan administrator must
separately account for the amounts that would be payable to an
alternate payee, and be careful that benefits are not wrongly
paid out to the participant, i.e., participant loans, hardship
withdrawals, or withdrawal of employee contributions.
It is the plan administrator's responsibility to declare that
a domestic relations order is a QDRO within a reasonable period
of time after receipt of the order. The plan administrator must
notify the participant and alternate payee as to whether the
order is a QDRO. If it is determined that the order is not a
QDRO, the plan administrator must provide the following
information to the participant and alternate payee:
- The reasons why the order is not a QDRO;
- References to the plan provisions on which the
determination is based;
- An explanation of any time limits that apply; and
- A description of any additional information or
modifications necessary for the order to be a QDRO and an
explanation as to why it is necessary.
As a practical matter, the plan administrator will ordinarily
contact its pension and/or legal advisors for confirmation that
the court order is a valid QDRO and for assistance in complying
with both the procedural notice requirements and implementation
of the QDRO.
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Access to Plan Information
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The plan administrator must provide prospective alternate payees
who are involved in a domestic relations order proceeding access
to plan and participant benefit information sufficient to
prepare a QDRO, such as the summary plan description, a copy of
the plan document and a statement of the participant's benefit
entitlement.
The plan administrator may condition disclosure of such
information to a prospective alternate payee on some reasonable
basis for concluding that the request for information is being
made in connection with a domestic relations proceeding.
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When Benefits Can Start
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In general, pension law does not require payments to begin to an
alternate payee until the "earliest retirement age" of
the participant, defined as the earlier of two dates:
- The date the participant is entitled to a withdrawal under
the plan, or
- The later of either:
- The date the participant reaches age 50, or
- The earliest date on which the participant could begin
receiving benefits under the plan if the participant
separated from service.
Such payments are permitted even though the participant is
still employed at the time and intends to remain employed in the
future.
Plan documents or written QDRO procedures may permit earlier
distribution of benefits to the alternate payee. Many plans
avail themselves of the opportunity to provide immediate
cash-out of alternate payee benefits in order to avoid the need
for segregated accounts, extended division of present and future
benefits and other administrative headaches.
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Divisions of Benefits
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The method used for dividing the retirement benefits payable to
an alternate payee will depend upon whether the plan is a
defined benefit plan or a defined contribution plan.
Defined Benefit Plans
Generally, a defined benefit plan provides a specific benefit
determined and payable at retirement. The benefit is usually
determined based upon factors such as years of service and
compensation of the participant, and is payable in the form of a
monthly benefit.
Because of the nature of the benefits provided by defined
benefit plans, division of such benefits in divorce proceedings
may raise complex issues. Benefits may have not yet fully vested
in the participant, and there may be substantial future accruals
which may or may not be taken into account under the QDRO.
Valuation of defined benefit amounts may be based on a variety
of methods.
Many defined benefit plans do not allow lump sum payouts to
alternate payees. Therefore, the alternate payee must accept an
annuity form of benefit, which may not be payable until the
participant is entitled to retirement benefits.
Defined Contribution Plans
Instead of promising a future benefit like defined benefit
plans, defined contribution plans provide an individual account
for each participant. The account grows through employer and/or
employee contributions, earnings and, in some cases, forfeitures
from the nonvested portion of the accounts of terminated
participants that are reallocated to the remaining participants.
For defined contribution plans, the alternate payee generally
receives a percentage of the participant's vested account
balance (such as 50%) as of a particular date, although a dollar
amount may be specified. If the parties agree as to the division
fraction and if immediate distribution is permitted and
selected, the only remaining issue may be how currently to value
the alternate payee's interest since many defined contribution
plans are not valued on a daily basis.
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Tax Treatment
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Payments to a participant's spouse or former spouse are taxable
to the spouse. The spouse or former spouse of the participant
may elect to have all or a portion of a lump sum payment
pursuant to the QDRO directly rolled over to an IRA or another
qualified retirement plan, thereby deferring the tax. Any
portion not rolled over is generally subject to federal income
tax as well as any applicable state income tax but not the 10%
early withdrawal penalty.
Distributions to other alternate payees, such as the child of
the participant, are taxed as income to the participant, may not
be rolled over and are not subject to the 10% early withdrawal
penalty.
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Modifying QDRO Benefits
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Earlier this year, the DOL issued Advisory Opinion 2004-02A
regarding modifications made by a court to an existing QDRO.
This guidance states that a new domestic relations order
covering the same parties can alter a prior one so long as the
new order meets the qualification requirements for a QDRO.
Generally, the changes would only apply to future payments.
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Allocating QDRO Benefits
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In May 2003, the Department of Labor (DOL) issued Field
Assistance Bulletin (FAB) 2003-3, which completely reversed its
prior position regarding charging an individual participant's
account for the fees related to a determination of the validity
of the participant's QDRO. Prior to FAB 2003-3, plans were
permitted to pass on QDRO determination expenses to the plan as
a whole but not directly to the account of the participant
involved in the QDRO. Plans are now permitted to allocate
reasonable expenses associated with QDRO determinations directly
to the participant's account.
In order to take advantage of the DOL's new position, the
plan's document may need to be amended to include specific
provisions for the allocation of expenses. In addition, plans
must include information in the summary plan description
concerning any expenses that could be charged against a
participant's account.
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Conclusion
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QDROs require special language and should be carefully reviewed
to make sure they meet the requirements of the law and are
administrable under the terms of the plan. The protection
afforded by the federal government to a divorcing spouse adds
one more administrative chore for the plan administrator. But
with proper consulting and legal advice, the plan can handle
QDROs without a great deal of strain.
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