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How to Guarantee Provisions of the Property Settlement Agreement by Means of a Qualified Domestic Relations Order

It is commonplace for a marital/community property settlement to provide that upon the occurrence of a future event (certain or contingent) one of the spouses is obligated to make a payment to the other. For purposes of this Practice Aid assume that the pension plan participant has incurred an obligation to pay the Wife $50,000.00, not later than June 22, 2005. It is emphasized that this is an obligation unrelated to the equitable distribution of the marital/community/community portion of the pension. For example this liability of the Husband to the Wife might be attributable to a future sale of property, stock options or some other asset. Further assume that the Husband age 44 is a participant in a 401(k) Plan and that his accumulated interest in this plan is currently $88,000.00.

The Property Settlement Agreement provided that the Wife will receive a security interest to the extent of $50,000.00 of the Husband’s 401(k) Plan [a Qualified Defined Contribution Plan]. The purpose of this security interest/lien is to guarantee that the award made to the Wife in the 2003 Property Settlement Agreement will be realized not later than June 30,2005.

Issue: Is a security arrangement in which a lien is placed against the Husband’s interest in the Plan in accordance with the terms of a Qualified Domestic Relations Order an assignment permitted under Internal Revenue Code §401(a)(13)(B)?

Traditionally, a QDRO against a 401(k) Plan provides that the Wife (Alternate Payee) will receive her marital/community/community share of the 401(k) Plan as soon as administratively practicable subsequent to the qualification of the Qualified Domestic Relations Order. A QDRO is the appropriate vehicle to give to an Alternate Payee his/her interest in such Plan. However, the skilled practitioner recognizes that a 401(k) or similar Plan (Thrift Plan, Savings Plan, Profit Sharing Plan, etc.) beyond the equitable distribution of marital/community property. An alternate use of pension assets can be to further insulate an Alternate Payee from loss of future “guaranteed” or contingent obligations provided for in the divorce instrument. Too often the busy practitioner does not recognize that a QDRO, has uses beyond the equitable distribution of the marital/community portion of a pension. This Practice Aid endeavors to alert the practitioner to alternate uses of a QDRO against all Qualified Defined Contribution Plans.

What is discussed in this Practice Aid is a more sophisticated use of a QDRO. Troyan, Inc. views a lien as an excellent tool to “lock in” that portion of the award(s) to the Alternate Payee that might otherwise be defeated by a future breach of covenant incident to the divorce. Clearly, a Participant who causes dilution, diminution or extinction of such future interest of an Alternate Payee is subject to punitive action. Such remedy unfortunately requires the Alternate Payee to return to court and incur additional fees and expenses to receive that which was awarded to her in the Judgment of Divorce. We view the QDRO discussed herein as a device to minimize the risk to an Alternate Payee of loss of future benefits as a result of a breach of covenant by the Participant Spouse.

It is emphasized that absent this QDRO created lien the Husband (Plan Participant) has full discretion regarding the assets in his 401(k) Plan. Regardless of the language of the Property Settlement Agreement the Husband would have unfettered rights to take full or partial withdrawals/distributions from the Qualified Defined Contribution Plan. Were the Husband’s employment to be terminated or his Plan merged into another as a result of a sale or consolidation the problems of the Wife in receiving her $50,000.00 award would be compounded. To avoid such problems Troyan, Inc. has developed QDRO’s that are more expansive and have a broader reach than a traditional QDRO.

This concept has found Federal support in Private Letter Ruling # 9234014 and in Darby v. Commissioner, 97 T.C. 51 which stated:

Under the statute (section 414(p)(1)(A)(i) as enacted by REA '84…, the status of an order as a QDRO is not affected by whether the order makes the alternate payee an owner of the interest under the plan or merely gives the owner a lien or other security interest in the plan. (emphasis mine)

We do not intend to communicate the impression that drafting of “security lien” Qualified Domestic Relations Orders is a routine task. However, an examination of a key drafting guide, the Pension Welfare and Benefit Administration’s drafting guideline reveals no bar to such form of Order. It is to be noted that this guideline expressly states that it represents the view of the Department of Labor. As the Retirement Equity Act makes clear, it is the Department of Labor, not the Internal Revenue Service that is the ultimate arbiter of the QDRO rules. Nevertheless, as indicated above at 97 T.C. 51 there is IRS support for the argument Troyan has presented.

Still caution is merited. The inexperienced practitioner may craft his/her Order so as to fail to recognize the many nuances that must be treated in this complex QDRO. Space and the desire to have you contact this office for your drafting needs precludes an exhaustive discussion of such nuances. Moreover, few Plan Administrators are eager to receive this type of QDRO. Be prepared for some reaction to this form of Order. As you are aware Plan Administrators favor simple boilerplate that readily conforms to some standardized format. At a minimum the practitioner should be mindful of the following prior to drafting:

  • Internal Revenue Code §401(a)(9)(C) and mandatory distributions.
  • Internal Revenue Code §417 as it relates to death benefits.
  • Regarding death benefits, Fox Valley & Vicinity Constr. Workers Pension Fund v. Brown , 897 F.2d 275 (1989) and its conflicting progeny.
  • Tax attribution rules as indicated @ Lucas v. Earl, 281 U.S. 111 (1930).
  • The subject Plan’s early distribution rules.
  • The subject Plan’s reporting and disclosure rules.
  • Qualified Defined Contribution Plan Reversion Rules.
  • PWBA qualification guidelines.