Divorce is always a tricky process to navigate. But add an imminent retirement and a host of pension funds to the mix, and you will find yourself facing an entirely new animal. For those who are entitled to a share of their soon-to-be ex’s pension plan and benefits, preparing a Qualified Domestic Relations Order (QDRO) is absolutely necessary.
When you file a QDRO, you are establishing your legal right to receive a percentage of payments (i.e., the account balances). Essentially, this document will make you the co-beneficiary of existing accounts.
When filed properly, a QDRO is an asset for any couple having to divide their retirement accounts. However, oblivious spouses make several mistakes that lead to unfair divisions and poor payouts. To protect your future and ensure you are receiving what you are entitled to, avoid the following costly QDRO mistakes, which have the potential to derail your retirement.
Not specifying plan names, types, and dates
Within settlement agreements, common mistakes are forgetting specifics and being too erroneous while drafting up the QDRO. Simply referring to a vague “retirement account” and an unspecified “lump sum” leaves too much room for interpretation: One spouse could argue that the sole intent of the QDRO was to split your 401K account—and not your pension plan.
The order should also set a clear date that each account is to be divided. It is critical to be as clear as possible, so that neither party can argue the intention later on.
Attempting to divide an indivisible plan
Specifying the plan type is also a crucial component of determining whether or not a plan can be divided. Too often, QDROs are drafted that attempt to divvy up a plan that is indivisible. Only plans that fall under the Employee Retirement Income Security Act (ERISA) of 1974 are qualified, and not all retirement benefits are required to follow these guidelines.
Non-ERISA plan (e.g., supplemental and excess benefit plans) are not subject to division by a QDRO. Additionally, a majority of these “golden handcuff” plans do not include survivor benefits, and they terminate the moment the employee passes. To avoid future litigation, it is critical that you and your attorneys know the type of plan before settlement agreements take place.
Forgetting to address gains and losses
Defined contributions plans (e.g., a 401K) fluctuate with the market. As payouts for qualified plans can take upwards of 90 days from the date the agreement was signed, it is important to address whether or not gains and losses will affect the dispersed sum.
The gross dollar value of the plan is almost guaranteed to change. How much it changes depends on the amount invested. In the agreement, make sure to indicate whether the amount dispersed will reflect those gains and losses, or will remain stagnant after the date of signing.
Not considering tax implications during division
All plan types are not equal. When dividing assets and retirement accounts, understand the tax implications that come along with each of them. In the case of a pre-tax account (e.g., a 401K) the government will be entitled to its share when it is taken out during retirement. In contrast, an after-tax account (e.g., a Roth IRA) is not deducted upon withdrawal.
In other words, if a divorcing couple is agreeing to split a 401k and a Roth IRA that are equal amounts, then the spouse receiving the Roth IRA will gain more—since that money will not be taxed. To avoid being short-changed, make sure you understand the tax implications during the settlement.
Disregarding a loan balance
If a loan balance exists on a defined contribution plan, it must be addressed in the QDRO. Should the loan balance amount to more than the entitled payout, the account will show insufficient funds.
Perhaps a loan balance has been worked into the QDRO, but there are recurring repayments on it. If so, the document needs to define whether the payment sum will reflect the loan balance on the date of signing (or the date of division).
As is the case with all aspects of divorce, maintain a clear head. Then you will be able to focus on the details and seek assistance from qualified professionals in the legal and financial fields. A small oversight on one document can derail a long, happy retirement, so take the necessary steps to protect yourself and your financial future.