Understanding the key issues will help in drafting Settlement Agreements and avoid post judgment problems.
The rules for Defined Contribution 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 Contribution Plans
Type of Plans
- 401(k) plans, profit sharing plans and Employee Stock Ownership Plans (ESOP) are offered by non-governmental plans.
- 403(b) tax sheltered annuity plans are offered by public schools and hospitals.
- 457 plans are offered by States and Municipalities.
Contributions
- Employee contributions are typically made by salary reduction and thus are pre-tax. This means they are not subject to income tax when made and are taxable along with any investment gains when distributed. 401(k) plans may offer a Roth option where the contributions are made after-tax and not taxable along with any investment gains when distributed.
- 401(k) plans may have matching employer contributions. Profit sharing plans and ESOPs are funded through employer contributions.
Marital Portion
- Marital Fraction. The numerator of the fraction is the number of months of marriage and the denominator is the total number of months from the initial date of participation to the date of divorce.
- Subtraction Method. The value of the account as of the date of marriage is subtracted from the value of the account as of the date of the divorce. Before choosing this method, the participant needs to provide the value as of the date of marriage. Changes in record keepers may mean this amount is not available.
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 the date of divorce can be assigned to alternate payee even if participant is not vested.
Distributions
- Typically, the alternate payee can take an immediate distribution. However, it is possible that a plan may not permit the alternate payee to take a distribution until the participant has reached the earliest retirement age.
- If the plan is funded through TIAA CREF, amounts held under the TIAA account cannot be taken in a lump sum.
- ESOPs often have restrictions on when the account can be valued and when a distribution can be taken. Check to see what the rules are before the Settlement Agreement is drafted.
- A 10% premature distribution penalty does not apply to a distribution made via a QDRO.
Key Issues with Non-Qualified Deferred Contribution 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.
- Considered unfunded because assets are available to the employer’s creditors.
- Treasury regulations for non-qualified plans permit division by QDRO, but many plans will not accept a QDRO.
- If not divisible by QDRO, assigned benefit must be paid by the employee to their former spouse when the employee receives the benefit. This creates tax issues, which should be addressed in the Settlement Agreement.
- If contributions are not subjected to FICA tax when made, FICA will apply to the lump sum present value when distributed if participant has not met FICA maximum for that year. The entire distribution is subject to Medicare tax.