Understanding key issues will help in drafting Settlement Agreements and avoid post judgment problems.
The rules for Defined Benefit plans differ depending on whether the plan is a qualified plan, which includes non-governmental plans subject to ERISA (Employee Retirement Income Security Act) and governmental plans not subject to ERISA but which often mirror ERISA rules for ease of administration, or a non-qualified plan which covers highly compensated individuals and is usually offered in addition to a qualified plan.
The rules for QDROs are found in Internal Revenue Code 414(p) and subsection 414(p)(11) provides the rules for governmental plans. A non-qualified plan may, but is not required to, accept a QDRO to assign a portion of the benefit to an alternate payee.
Key Issues with Qualified Defined Benefit Plans
Type of Plan
- Determine if it is a final average earnings (FAE) monthly formula or a cash balance account formula. Some plans may have started as a FAE formula and changed to a cash balance formula. In that case, the employee may have only one or the other, or may have both.
- A FAE benefit can only be paid as a monthly benefit. A cash balance benefit may be paid as a lump sum or a monthly benefit.
- A FAE benefit typically can only be paid as of the earliest retirement age. A cash balance benefit usually, but not always, can be paid immediately to the alternate payee.
Vesting
Non-vested assets may be divided. Bornemann v. Bornemann, 245 Conn. 508, 752 A.2d 978 (1998). A portion of participant’s benefit calculated as of date of divorce can be assigned to alternate payee even if participant is not vested.
Marital Portion
- FAE Formula: Use marital fraction, where numerator is number of months of marriage and denominator is total months from initial date of participation to date of divorce.
- Cash Balance Formula: Can use marital fraction, or subtraction method where value at date of marriage is subtracted from value a date of divorce.
Shared vs. Separate Interest
- Shared Interest: The benefit is paid over the life of the participant or over the lives of the participant and a survivor annuitant. This is typically required with a governmental pension and is required for any pension that is in pay status when the QDRO is submitted. The benefit paid to the alternate payee ceases at the death of the participant unless the benefit is paid as a joint and survivor annuity with the alternate payee as the survivor annuitant.
- Separate Interest: The benefit is paid over the life of the alternate payee and is not affected by the death of the participant after payments commence.
Pre-Retirement Survivor Benefit
- Shared Interest: With most governmental plans, the alternate payee cannot be treated as a surviving spouse and thus is not eligible for the monthly pre-retirement survivor annuity. You can assign via a QDRO all or a portion of any employee contribution account, but the contributions are not available for distribution if the participant has remarried as of the date of death. The alternative is to consider life insurance.
- Separate Interest: With some non-governmental plans, the alternate payee will lose the assigned benefit if the participant dies pre-retirement and the alternate payee is not named as the pre-retirement survivor annuitant. The Settlement Agreement should provide that the alternate payee will be treated as a surviving spouse to the extent necessary to ensure that she/he receives the assigned benefit.
Post-Retirement Survivor Benefit
- Shared Interest: If the alternate payee is assigned a shared interest payment, the assigned benefit will cease if the participant is the first to die, unless the participant is required to elect a joint and 50% or 100% survivor annuity with the alternate payee as the survivor annuitant. If the participant is the first to die, the alternate payee will receive the designated percentage of the total benefit being paid, typically receiving an increased benefit.
- With a joint and survivor annuity, the benefit amounts for the participant and alternate payee will be proportionately reduced because it guarantees payments over two lives.
Settlement Agreement Provisions
- Division Date. Typically, date of divorce, but can be date of retirement. [See Ranfone v. Ranfone, 103 Conn. App. 243 (2007)]
- COLA. Specify if a cost-of-living adjustment (COLA) should be awarded on the alternate payee’s share. If COLA is not awarded to the alternate payee, the participant gets the COLA on the alternate payee’s share of the benefit. Under CT caselaw, if the Settlement Agreement does not provide for COLA, the alternate payee is not entitled to it. [See Loiseau v. Loiseau, N. FA064005144, 2008 WL2553026, (Conn. Super. Ct. June11, 2008)] However, the courts typically accept a post judgment stipulation signed by both parties and filed with the QDRO.
- Early Retirement Subsidy. If not provided to the alternate payee and the alternate payee’s share is paid before the normal retirement age, the plan will apply the full actuarial reduction instead of the lesser adjustment under the subsidy, resulting in a smaller benefit paid to the alternate payee.
Key Issues with Non-Qualified Defined Benefit Plans
A non-qualified plan is generally available only to highly compensated individuals and is not subject to the qualification provisions of the Internal Revenue Code (IRC) that apply to qualified plans. These plans typically provide benefits in excess of the IRC limitations for qualified plans and there is no ERISA protection. This is a valuable benefit that often is not disclosed.
- Considered unfunded because assets are available to the employer’s creditors.
- Treasury regulations for non-qualified plans permit division by QDRO, but many employers will not accept a QDRO.
- If not divisible by QDRO, the assigned benefit must be paid by the employee to the former spouse when the employee receives the retirement benefit. This creates tax issues which should be addressed in the Settlement Agreement.