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DIVISION OF DEFINED CONTRIBUTION PLANS – TREATMENT OF LOANS

Too often that which appears to be a simple matter is in fact more complex. This view applies to the division of pension assets from Defined Contribution Plans. Let us use a simple example to illustrate the danger of oversimplification and poor drafting of a Property Settlement Agreement.

John and Mary are divorcing. One of John’s pension assets is a 401(k) plan containing $180,000.00. The full balance would be $220,000.00 but, there is an outstanding loan in the amount of $40,000.00. Thus, the distributable amount is $180,000.00. It is agreed that Mary’s share is $90,000.00. A Domestic Relations Order is prepared giving Mary $90,000.00 from John’s plan.

If you were the attorney representing the titled spouse and you endorsed a settlement akin to the above you may have cause for concern. What John and Mary did was divide the existing value of the account. What you endorsed was a settlement that did not recognize the $40,000.00 outstanding loan liability. What you did was to divide the asset but you have failed to divide the liability. The attorney representing the titled spouse permitted Mary to get half of the net worth of the account but no obligation regarding pay back of half of the liability was incorporated into your Property Settlement Agreement.

In sum the attorney representing the titled spouse has crafted or endorsed a settlement that requires the titled-spouse to assume the full loan liability. Yet the proceeds of the loan were mutually enjoyed by the spouses. Now the titled-spouse alone will be obligated to repay the loan in spite of the fact that the loan was equally enjoyed by both spouses.

MY MESSAGE:
In a divorce action involving any type of Defined Contribution Plan in which a loan exists at the time the asset is divided it is essential that the parties divide both the asset and the loan liability. Had this division been done with proper recognition of the loan Mary the Property Settlement Agreement would have contained a provision similar to the following:

Step I
Initial Amount for Mary
Half of the account balance: $90,000.00
($180,000 ÷ 2 = $90,000)

Step II
Loan adjustment for Mary: $20,000.00
($40,000 ÷ 2 = $20,000)

Actual amount distributed to Mary: $70,000.00
($90,000 – 20,000 = $70,000)

When your divorce involves a Defined Contribution Plan that contains a loan you may wish to contact Troyan, Inc. to confirm that the amount to be distributed to the non-titled spouse is correct.