Retirement accounts and benefits can be among the most valuable assets owned by parties who are divorcing. While parties can agree within their Separation Agreement to divide retirement assets between themselves in a particular way, the Separation Agreement itself is not a directive to the plan administrator (the person or company responsible for managing a retirement fund or pension plan on behalf of the participants) and will not suffice on its own to accomplish a division of retirement assets. Another separate order signed by the judge and sent to the plan administrator is necessary to effectuate the division of certain retirement benefits.
ERISA qualified retirement plans
ERISA (Employee Retirement Income Security Act of 1974) is a federal law that sets standards and provides protection for people participating in retirement and health plans in private industry. ERISA covers both defined benefit plans (pensions) and defined contribution plans (401(k), certain deferred compensation plans, and profit-sharing plans) offered by private employers. When a private defined benefit plan or defined contribution plan is divided as part of a divorce, a Qualified Domestic Relations Order or QDRO is needed.
A QDRO is a specialized court order that directs the plan administrator to allocate all or a portion of the retirement account/benefits to a former spouse as if the former spouse was also a participant in the retirement plan. A QDRO is a very technical document, which must meet requirements set out by the IRS and the retirement plan itself, and should be written by an expert in drafting such orders. A QDRO cannot create a benefit for a former spouse that is not allowed under the retirement plan.
Non-ERISA qualified retirement plans
ERISA does not cover state and federal government-sponsored retirement plans (including public pensions), 403(b) plans, retirement plans set up by churches, SEP-IRA accounts, or IRA accounts. These are known as non-qualified retirement plans.
While many IRA accounts can be divided between spouses via a non-taxable transfer from one IRA account to another using a form provided by the financial institution, dividing a pension or 403(b) plan is not that simple. For non-qualified retirement plans, a Domestic Relations Order, or DRO, is required. Like a QDRO, a DRO is a court order directing a plan administrator to assign all or a portion of a party’s retirement benefit to a former spouse. Nearly all state and federal pension plans require the participant to make certain elections at retirement – including whether to leave survivor benefits or to have the pension stop at the death of the participant. When survivor benefits are elected, there is a “cost” in that the monthly pension benefit to the participant decreases. When dividing a state or federal pension, the divorcing spouses must agree on both the option to be selected at retirement and allocation of the cost of survivor benefits are selected. These elections will be included in the DRO, but must also be included in the Separation Agreement, which acts as a guide to drafting the DRO.
Dividing an IRA, 401(k), pension, or other retirement benefits at divorce is not simple and requires careful consideration during the process of negotiating settlement terms and requires the help of an expert when a QDRO or DRO is drafted. Do not attempt to divide a retirement benefit without seeking legal advice. Doing so could result in tax consequences or penalties, or worse, loss to the non-employee spouse of a valuable interest in a substantial asset.