Employer-provided retirement plans including employee stock ownership plans (ESOPs) — as well as 401(k) plans and similar retirement savings plans, defined benefit payments, and pensions — represent a significant portion of an individual’s assets.
When a plan participant divorces a spouse, the division of joint marital property, assets, or family support obligations is one of the most significant (and often contentious) parts of negotiations and proceedings. That’s where QDRO distribution rules come into play.
While state laws vary with regard to the division of assets, federal laws cover employee retirement plan benefits, and any division of property must also comply with federal law.
According to the Department of Labor’s guide on the matter, the Employee Retirement Income Security Act of 1974 (ERISA) and Internal Revenue Code require that “Retirement interests may only be assigned if the judgment, decree, or order creating or recognizing a spouse’s, former spouse’s, child’s, or other dependent’s interest in an individual’s retirement benefits constitutes a ‘qualified domestic relations order’ or ‘QDRO.’”
For an ESOP administrator, this regulatory requirement should spark at least two key questions:
- What factors qualify a QDRO?
- What’s the best way to handle plan distributions to an alternate payee in the case of a QDRO?
Determining Whether a Domestic Relations Order is a QDRO
A domestic relations order (DRO) is a judgment, decree, or order made pursuant to state domestic relations law relating to the provision of child support, alimony payments, or marital property rights for the benefit of a spouse, former spouse, child, or other dependent of a plan participant.
A DRO may assign a portion or all of a plan participant’s benefits to one or more of these parties to satisfy the marital property or family support obligations of the plan participant — but before a distribution can be made from the plan, the administrator must determine that the order is a QDRO.
To meet qualification requirements and be acknowledged as a QDRO, the order must be a judgment, decree, or order issued by a state authority (including the approval of a property settlement agreement) that includes the following information:
- The name and last known mailing address of the plan participant and each alternate payee
- The name of each plan to which the DRO applies
- The percentage, dollar amount, or a method for determining the amount or percentage to be paid to the alternate payee(s)
- The number of payments or the period of time to which the DRO applies
- It must NOT require:
- The plan to provide any alternate payee(s) or participant any type or form of benefit or option that is not otherwise provided for under the plan
- The plan to pay benefits to any alternate payee(s) that are required to be paid to another alternate payee under another order previously determined to be a QDRO
- The plan to provide for increased benefits (i.e. – amounts that exceed 100% of the participant’s account balance in the plan)
- The plan to pay benefits in the form of a qualified joint and survivor annuity (QJSA) for the lives of the alternate payee and his or her subsequent spouse
A QDRO can only recognize as alternate payee(s) a spouse, former spouse, child, and/or other dependent of a plan participant. Typically, any pre-marital plan balance is not considered marital property, so gains and/or losses on the participant’s premarital portion of the account balance is generally excluded from the portion paid to a designated alternate payee.
ESOP Administrator Responsibilities for DROs & QDROs
In administering all orders received, the plan administrator should complete these actions:
- Establish and follow reasonable procedures to determine the qualified status of DROs and to administer distributions pursuant to QDROs
- Review the plan document and summary plan description (SPD) to determine what the plan allows for distribution timing and fee allocations for the participant and/or alternate payee(s)
- Send written notification to the affected plan participant and the alternate payee(s) named in a DRO that the order has been received, and furnish a copy of the plan’s procedures for determining the qualified status of such order
- Review the DRO and document the review, to determine the DRO meets qualification requirements (in particular, that it includes the information listed in the above section)
As a plan fiduciary, the plan administrator is required to act prudently and solely in the interest of plan participants and beneficiaries — and they’re required to follow the plan’s documented procedures for making a QDRO determination. The Department of Labor requires that plans establish timely, efficient, cost-effective QDRO determination procedures that are consistent with fiduciary duties under ERISA. The administrator is required to provide a clear explanation of the plan’s determination process.
Some plans’ QDRO policies and procedures are drawn up by an ESOP attorney, and some plans even provide sample QDROs for participants and their attorneys in divorce or custody proceedings. Plans aren’t required to provide QDRO forms, but they are allowed to, and providing a form may help address the questions of timeliness, efficiency, and cost to determine qualification.
QDRO Distribution Timing
The ESOP plan document dictates when a QDRO is eligible for a distribution. Typical options commonly found in plan documents are as follows:
- “Earliest retirement age” rule – Under this process, the QDRO is eligible for a distribution as soon as the employee reaches the earliest retirement age, as defined in IRC Section 414(p)(4)(B) as the earlier of the following:
(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.
- Immediate distribution to QDRO-designated alternate payee(s)
- Delayed distribution to the QDRO-designated alternate payee(s) until the employee is eligible for a distribution
Working with an ESOP expert can be an important step in determining the optimal payout option or options for your plan—and capturing them correctly in your plan document.
Who Pays Taxes on ESOP QDRO Benefits?
A spouse or former spouse who receives QDRO plan benefits reports the payment as if he or she were a plan participant; this includes the option for a tax-deferred rollover to another retirement plan. On the other hand, in the case of a QDRO distribution to a child or other dependent, the plan participant is taxed on the distribution.
Learn more about the most important elements of an ESOP distribution policy when you download our free guide to distribution timing, form, and method. Just click the link below to get your copy today.