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Retirement assets can be grouped into two main categories:
- Defined contribution; and
- Defined benefit.
A defined contribution account
An account that contains an amount of money or stock that belongs to you. Examples would be a 401(k) account or a 403(b) account. Your “benefit” from this type of retirement account depends or is “defined” by the amount of contributions made to the account. The contributions may be made by you or by your employer or some combination of the two.
A defined benefit retirement asset
Typically a pension. When you have a pension, there is not a particular account that contains money that belongs just to you. Instead, there is a giant pool of money that is used to fund monthly pension payments to a large group of people. The amount of the pension “benefit” you receive from this type of retirement asset is “defined” by a formula. Typically, the formula will include the number of years of service credits you have earned through your employment, your salary, and your age. For example, the amount of your pension may be calculated taking into consideration your years of employment (“service credits”), whereby you earn 2% of your final salary for each year you worked for your employer. Under this formula, if you worked 30 years for your employer before retiring, you will receive 60% of your final salary. Some pension plans look at your highest annual salary before applying the service credit percentage. Some pension plans will look at the average of your three highest earning years. The pension formula will also take into consideration your age. Pension plans require you to reach a certain minimum age (“earliest retirement age”) before you become eligible to start retirement benefits. For many retirement plans, the minimum age is 55. For other pension plans the minimum retirement age may be 65, 62, 50 or even as early as 40. Usually, the older you are, and the longer you delay retirement, the more your monthly pension payment will be. If you retire at age 55, your pension may be $2,500 per month. But, if you wait to age 60 to retire, your pension may be $3,500 per month because the pension plan will pay you for a shorter period of time. There are lots of different pension plans and lots of different formulas that are used to define the amount of your pension benefit.
The portion of your retirement assets that was earned during the marriage is community property and is typically equally divided upon your divorce. The portion of your retirement assets that was earned before marriage is your separate property. The portion of your retirement assets that is earned after the date you and your spouse separated is also your separate property.
Dividing defined contribution accounts:
Let’s assume you have a 401(k) account with $50,000 in it. Let’s assume some of the money was earned before marriage, some was earned during the marriage, and some was earned after you and your spouse separated. You want to equally divide the community property portion of your account with your spouse as part of the property settlement. How do you do it? You can’t just take money out of your retirement account and give it to your spouse. First, you can’t withdraw money from your account so long as you are employed by that employer, and even if you could, you would not want to make the withdrawal because you would then have to pay income taxes on the amount withdrawn, plus an early withdrawal penalty if you are under age 59 and a half.
What you should do is get a Qualified Domestic Relations Order, commonly called a “QDRO”. A QDRO is a special type of court order, authorized by federal law, that permits the custodian of your 401(k) account to take a portion of your 401(k) account assets and pay it over to your spouse as part of a divorce settlement. If you use a QDRO, there are no immediate income tax consequences to you or your spouse and no early withdrawal penalty. Also, the portion due your spouse can be transferred to your spouse right away. A QDRO is a court order that contains certain provisions required by federal law and also includes an instruction to the custodian of your 401(k) account telling the custodian how much of your account is to be paid over to your spouse. The QDRO may tell the custodian to pay a certain amount to your spouse, such as $20,000. A QDRO may tell the custodian to pay a certain percentage to your spouse, such as 50%. In the alternative, the QDRO instruction to the 401(k) custodian may say something like, the date of marriage was January 1, 2005, and the date of separation was June 30, 2018, pay your ex-spouse one half of all contributions made to your account between those two dates, adjusted for any accruals or losses on those contributions.
Dividing defined benefit retirement assets:
Assume you have worked for your employer for 30 years and your employer provides you with a pension as part of your compensation package. Also assume you have been married for the past 20 years. You are now getting a divorce. The portion of your pension benefit that was earned during the marriage is community property and would typically be divided with your spouse. How do you divide the community property interest in the pension?
One option is to have the community property interest in your pension appraised and then buy out your spouse. You can hire an actuary to calculate the value of the community property interest in your pension. An actuarial appraisal should not be very expensive, around $300. You can Google “pension valuation” and get some quotes for the appraisal. A pension buyout is usually not a good idea for a number of reasons. First, you have to understand that when actuaries value pensions, they do not discount the pension for income tax consequences. In other words, they treat the pension payments as if the payments will be tax free, which they are not. Second, there is the issue as to where the money will come from to pay your spouse the buyout amount. Pensions can be very valuable and the buyout amount can be large. Third, you may be young and your pension may not be payable for another 20 or 30 years, assuming you live that long. Do you want to pay a lot of money today for pension payments you won’t see for many years? Fourth, if you will be paying your ex-spouse child support or spousal support for a period of years, including after you retire, then you do not want to buy out your spouse’s interest in your pension and later have the court use that pension income for purposes of calculating how much support you owe.
The better approach is to split the pension benefits by using a QDRO. A pension QDRO is generally going to split the pension by means of a time rule formula. For example, assume you worked 10 years before marriage, 20 years during the marriage, and another 5 years after you separated from your spouse. You worked a total of 35 years to earn the pension. You were married for 20 of those years. That means that 20/35ths of your pension was earned during the marriage or about 57%. If your pension payments when you retire are $1,000 per month, 57% would be community property or about $570 per month. Your spouse would be entitled to about half the community amount or about $285 per month. You would receive the rest. The actual amount of the pension payments each party receives will also depend on each party’s age and other factors.
The pension QDRO will typically recite the date of marriage and the date of separation and then instruct the pension plan administrator to allocate the pension benefits using a fraction where the numerator is the number of years of service credits earned during the marriage and the denominator is the total number of years of service credits earned during the entire period of your employment. Said fraction will determine the community property share of the pension benefit. The pension administrator will then write two pension checks each month, one to you for your share of the pension and one to your ex-spouse for his or her share of the pension.
There are other ways a pension QDRO can divide the community property interest in a pension and there are other issues that should be addressed in a pension QDRO, including what happens if one spouse dies before the pension payments begin. If you hire a qualified professional to draft your QDRO, these issues should be properly addressed in the QDRO.
How do you obtain a QDRO? There are two basic options. One option is to hire an expert to draft the QDRO. The experts that are in the business of drafting QDROs are typically accountants or actuaries, although some are lawyers. You can Google “QDRO drafting” and find an expert to draft a QDRO for you. You can expect to pay somewhere in the neighborhood of $500 to $600 per QDRO. Another approach is to draft your own QDRO using a model and instructions provided by your retirement plan administrator or custodian. Not all retirement plan administrators provide model QDROs and instructions, but many of them do. Call the administrator for each of your retirement plans and ask if they can mail or email you a model QDRO and a set of instructions. When you receive the model, follow the instructions and prepare your own QDRO.
Some plan administrators and plan custodians have model QDRO and instructions on-line, with fillable forms. For example, if Fidelity is the custodian of one or more of your retirement assets, go to https://qdro.fidelity.com/ and log in. After you log in, click “create a new QDRO” and then type in the name of your employer or the name of your retirement plan to see if Fidelity has a model for that particular plan. If Fidelity has a model, follow the on-line instructions and then print your QDRO.
What do you do with your QDRO after it has been drafted?
You now have your QDRO drafted. The next step is for you and your spouse to date and sign the QDRO. Some courts will require that your signatures on the QDRO be notarized. The safe approach is to get your signatures notarized. The next step is to get a judge to sign the QDRO. Take your original QDRO and a copy to the court clerk, together with a self-addressed stamped envelope. The court clerk will give the QDRO to a judge to sign. After the judge signs the QDRO, the court clerk will mail you a filed-endorsed copy of the QDRO.
Many retirement plan administrators will accept a filed-endorsed copy of the QDRO. However, many plan administrators, particularly when you are dealing with retirement benefits through government entities, will insist on a certified copy of the QDRO. A certified copy is different than a filed-endorsed copy. A certified copy has an extra seal that the court clerk puts on the copy that certifies that the copy is a true and correct copy of the original document. When you drop off your QDRO with the court clerk, include a cover letter that tells the court that you want a certified copy of the QDRO, not just a filed-endorsed copy. Some courts charge a filing fee when you submit a QDRO as well as an extra fee for a certified copy. For example, a court may charge you a QDRO filing fee of $20, plus fifty cents per page, plus another $25 for the certified copy. You are going to need to bring your check book or credit card with you when you drop off the QDRO with the court clerk. Ask the court clerk how much you need to pay for the filing fee and certification fee.
After you get the certified copy of the QDRO back from the court, make a copy for yourself and a copy for your spouse. Then, take the certified copy and mail it to the plan administrator. When you mail the QDRO to the plan administrator, include a cover letter. Your cover letter will ask the administrator to review the QDRO and confirm that the QDRO is acceptable to the administrator. Your cover letter must also provide the plan administrator with your date of birth, your social security number, your spouse’s date of birth, and your spouse’s social security number. The address of the plan administrator is usually set forth in the QDRO.
The plan administrator will take some time to review the QDRO and let you know if the QDRO is acceptable. Some plan administrators will get back to you in a few weeks. Others will take a few months. Some government agencies can take a year or longer. Don’t lose track of the QDRO approval. If you have not heard back from the administrator within a few months, contact the administrator. You don’t want the QDRO to slip through the cracks, which can happen. You need to receive a letter from the administrator saying the QDRO is acceptable.
Sometimes the administrator will send you a letter saying they want revisions to the QDRO before they will consider it acceptable. If this happens, and you used a professional to draft the QDRO, send the letter to the professional. He or she will make the revisions and issue an “Amended QDRO”. If you drafted the QDRO on your own, then you will need to make the revisions yourself. When you make the revisions, include in the caption, just below the case number, the word “Amended” (i.e., “Amended Domestic Relations Order Regarding XYZ Corporation 401(k) Plan”) so there is a distinction between the first QDRO you filed with the court and the amended QDRO. After you have your amended QDRO, go through the same process (i.e., file it with the courts so a judge will sign it; get a certified copy; and then mail the amended certified copy to the plan administrator with a cover letter requesting that the administrator review and approve the QDRO).
QDRO Review Fees:
Some retirement plan administrators charge a fee to review a QDRO. Many administrators do not charge any fee to review a QDRO. If a review fee is going to be charged, the administrator will take the fee out of the retirement account. For example, if the fee to review a QDRO for a 401(k) account is $300, when the administrator divides the account pursuant to the QDRO, they will typically deduct $150 from your share of the account and $150 from your spouse’s share of the account. Some administrators charge hefty review fees. You can pay more for a review fee than the amount you paid to have a professional draft the QDRO. Some administrators won’t charge a review fee or will charge a reduced review fee if you use their model QDRO. Fidelity tends to charge very hefty review fees if they have a model QDRO on their website and you don’t use it, but instead hire a professional to draft a QDRO that differs from the Fidelity model.
After the administrator reviews your QDRO and sends you a letter confirming that the QDRO is acceptable, then what happens? It depends on which type of retirement asset you have. If you have a defined contribution asset such as a 401(k) account, the administrator will send documents to the non-employee spouse asking that spouse how they want their share of the account handled. The spouse will be given at least a couple of options. One option may be to have their share remain in a separate account with the administrator. Another option may be to have their share paid out to another retirement account custodian, such as the custodian of an IRA. Your spouse can open an IRA account with a bank and have their share of your 401(k) rolled into the IRA account. This is what most people do. A third option is to take a cash distribution. Most people don’t take a cash distribution because, if they do, they will have to pay state and federal income tax on the distribution.
If the QDRO pertains to a defined benefit plan (pension), then there is no account to pay out. Instead, your ex-spouse will wait until the pension becomes payable. When the pension becomes payable, they will receive their share of the pension each month directly from the pension plan administrator. It is very important after the QDRO is in place that your ex-spouse keep the pension plan administrator informed as to their address. QDROs always set forth the address of both parties. However, if the pension isn’t paid out for another ten or twenty years, it is likely that one or both parties will move multiple times in that ten or twenty year period. When it comes time to pay out the pension, if the administrator does not have a current address for you or your spouse, the administrator is not going to know where to send the pension payments.
When is the pension payable? The person that earned the pension is the “participant”. The other spouse is the “alternate payee”. Let’s say the pension plan provides that the “earliest retirement age” is 55. The participant reaches age 55, does not want to retire, but instead intends to work until age 65. The alternate payee wants to start receiving their share of the pension when the participant turns 55. Many pension plans include a “Gilmore” provision that will permit the alternate payee to start receiving their share of the pension as soon as the participant reaches the earliest retirement age, even if the participant elects to keep working. The QDRO should spell out whether or not the alternate payee will have this option.
Reducing the number of QDROs:
You don’t need to draft a QDRO for each and every qualified retirement asset you and your spouse own QDROs can get to be very expensive, particularly if you have a lot of retirement assets. Some people may have switched employers multiple times over their career and have three or more 401(k) accounts. Their spouse may also have multiple retirement accounts. If you and your spouse own a total of six 401(k) accounts and you are going to spend $500 on an actuary to draft each QDRO, you are talking about a significant amount of money, not to mention the hassle of dealing with the QDRO approval process for six different accounts.
You may want to offset the accounts. For example, if you have four 401(k) accounts containing a total of $500,000 of community money and your spouse has two 401(k) accounts with a total of $300,000 in community money, you may be able to equally divide all of the accounts with just one QDRO. Have your settlement agreement say that your spouse will keep all of his or her retirement accounts, that you will keep all of your retirement accounts, except one QDRO will be used to equalize the division of all of the accounts. The difference in value between your retirement accounts and your spouse’s retirement accounts is $200,000. If you have $100,000 paid out of one of your retirement accounts to your spouse pursuant to one QDRO, both parties will then end up with $400,000 of retirement assets. Instead of drafting six QDROs, you used just one QDRO to equally divide all six accounts.
Joinder of retirement plans:
Most retirement plans that are associated with a California public entity (i.e., a retirement plan that was earned by working for a city, a county, the State of California or some other public entity) will not honor a QDRO unless the public entity has been made a party to the divorce action. This means you have to “join” the retirement plan to your divorce case. You accomplish the joinder by completing three Judicial Council forms, filing those forms with the court clerk, and then mailing filed-endorsed copies of the forms, together with a blank “Notice of Appearance” form, to the retirement plan administrator. The required forms are as follows:
- Request For Joinder Of Employee Benefit Plan And Order (FL-372)
- Pleading On Joinder – Employee Benefit Plan (FL-370)
- Summons Joinder (FL-375)
- Notice of Appearance And Response Of Employee Benefit Plan (FL-374)
You do not need to have a process server formally serve the joinder forms on the plan administrator. You only have to mail them to the administrator. A good practice is to fill out the joinder papers, file them with the court clerk, and mail them to the plan administrator at the same time you send the administrator the certified copy of your QDRO. The retirement plan administrator won’t file the Notice of Appearance with the court. The administrator will not actually “appear” in your divorce case. You just have to jump through the hoop of joining the retirement plan to the divorce action as part of the process of getting the government retirement plan to honor your QDRO.
The United States government does not require the joinder process. Nor do most non-government retirement plan administrators. If you or your spouse earned your retirement benefits by working for a private company, you will not need to bother with the joinder pleadings.
Omitting retirement assets:
You have to be very careful when it comes to identifying retirement assets. Many people don’t understand what retirement assets they have. It is very common for people to think they only have a 401(k) account and not realize they also have a pension. Some employers offer multiple types of retirement benefits. You don’t want to overlook any retirement asset. If you are getting divorced, both you and your spouse should check with your employers to confirm you know about all retirement assets you have.
IRA accounts don’t need QDROs:
QDROs apply to “qualified” retirement plans. An IRA account is not a “qualified” retirement plan. You do not need a QDRO to split an IRA account. All you need is a court order. For example, assume you have an IRA account in your name that contains $50,000 and it is all community property money that will be split with your spouse. You can’t just take $25,000 out and pay it to your spouse. If you were to do that, you would have to pay state and federal income taxes on the withdrawal, plus an early withdrawal penalty if you are not age 59 and a half. What you need to do is to get a court order that awards your spouse the $25,000 from your IRA. The court order you need will be your divorce judgment. The divorce judgment needs to include a provision that spells out what amount or what percentage of your IRA your spouse is to receive.
After you have the court order (i.e., divorce judgment), have your spouse go to the bank, brokerage firm, or other institution where you have your IRA. Have your spouse open an IRA account with that entity. Then, give the entity a letter instructing the entity to make the transfer from your IRA account directly into your spouse’s newly created IRA account. Some entities will want more than a letter. Some will want a copy of the court order. Some will want you to fill out various additional forms before they will make the transfer. After the transfer is made, your spouse can move the money wherever he or she wants to keep their IRA.
It is critical that you not make the transfer until after you have the court order awarding your spouse part of your IRA. If you make the transfer before the court order is issued, the transfer will be taxable and subject to an early withdrawal penalty. Wait until you have a filed-endorsed copy of the court order (judgment) in your hand before you make the IRA transfer.
Unvested retirement assets:
Retirement assets can be vested or unvested. For example, your employer may require that you work for 5 years before becoming vested in a pension plan. If you work for only 4 years and then quit or get laid off, you will not receive any pension benefits. Some people think that an unvested retirement asset can be ignored in their settlement agreement because the right to receive the retirement benefit has not yet been perfected. This is incorrect. All retirement benefits, vested or unvested, should be identified in your divorce judgment and disposition of the retirement assets should be addressed in the judgment. If you or your spouse have unvested retirement assets through your current employer, your settlement agreement should address the unvested retirement asset. You can have a QDRO prepared to deal with an unvested pension. If the pension never vests, neither party will receive any benefits. However, if the pension does vest in the future, each party will receive their fair share.
QDROs and divorce judgments:
When you are dividing retirement assets, your divorce judgment needs to set forth the basic agreement about how those assets are to be divided. A QDRO is a document that is separate from the divorce judgment. Your divorce judgment may state in general terms that the community property interest in your 401(k) account or your pension will be equally divided by means of a QDRO. You will need follow up the divorce judgment by drafting a QDRO that will contain more detailed language explaining exactly how the community property interest will be equally divided. It’s not enough that your divorce judgment states that the community property interest in certain retirement assets will be equally divided. You also need to have the QDROs.
Many people procrastinate when it comes to getting QDROs drafted. They get the divorce judgment and don’t follow-up with getting the QDROs drafted. Don’t let this happen. One party could lose important retirement rights if a QDRO isn’t drafted in a timely manner. For example, a pension can be payable to the person that earned the pension. If the person that earned the pension dies, a survivor benefit can be paid to the deceased person’s spouse. Once your marital status has been terminated by a divorce judgment, you are no longer the other person’s spouse. A QDRO permits a plan administrator to make pension payments to an ex-spouse, even if the plan participant has died. If the person that earned the pension dies after the divorce judgment terminates the parties’ marital status, but before a QDRO is in place, the surviving party will likely forfeit any right to the pension payments. You want to get the QDROs finalized and accepted by the plan administrators before your marital status is terminated. If this is not possible, get the QDROs done as soon as you can.
We include sample provisions for the disposition of retirement assets in our “Marital Settlement Agreement” template, which is discussed in another section of our website. [See, “Judgment” and then the sub-topic, “Agreement Template”]. The retirement assets provisions can be part of a Marital Settlement Agreement that is attached to your divorce judgment or, if your judgment is going to be a collection of Judicial Council forms, the retirement asset provisions can be a “stand alone” attachment to the property division Judicial Council forms, which are discussed in another section of this website. [See, “Judgment” and then sub-topic, “Forms Approach”].