Drafting Judgment Provisions For Dividing Retirement Plans
Drafting Judgment Provisions For Retirement Plans


Lake County Bar Association Family Law Seminar
October 21, 2011

There are things all attorneys should watch out for in drafting a Judgment or Marital Settlement Agreement even if they are not preparing the qualified domestic relations order (QDRO.

I. Distinguish various types of retirement plans. You can do different things with different types of plans. Retirement plans have very different restrictions. It is wise to put different provisions in the MSA depending on the type of plan.

A. Corporate or union pensions and 401(k) plans – These plans are governed by federal Employee Retirement Income Security Act [ERISA] and can only be divided by a QDRO.

B. State or local government pensions – can only be divided by Qualified Illinois Domestic Relations Order [QILDRO].
1. The benefit that can be divided is more limited than for a corporate pension -- monthly payments will only be made to the alternate payee while the member receives benefits. There are no survivor benefit and there are limited death benefit.
2. Disability benefits cannot be divided by QILDRO – this is especially a concern for spouses of fire and police personnel. The member can choose to stay on disability rather than taking the pension. But see IRMO Schurtz, 891 N.E.2d 415.

C. Federal civil service retirement plans [FERS and CSRS] and Thrift Savings Plan [TSP]. These plans have their own requirements. The federal government has issued detailed regulations with model wording for different situations and rules for interpretation. To divide these plans you must submit a “Court Order Acceptable for Processing" [COAP] instead of a QDRO.

D. Military Pensions -- Different federal law governs these plans than plans for civilian personnel. The benefits available to an ex-spouse are limited.
1. 10/10 requirement. For the military to make direct payments from a pension, the parties must have been married for at least 10 years during which the member performed 10 years of creditable service. If the marriage does not meet this qualification, the court can still order the member to make payments to his or her ex-spouse as a division of marital property.
2. Survivor Benefit Plan. [SPB] Military survivor benefits payment. SPB is required if alternate payee is going to receive payments after the member dies.
a) People forget to mention it in the MSA when they refer to dividing the pension. If an SPB is not mentioned in the Judgment, the alternate payee will have difficulty arguing that they are entitled to it later.
b) Even if SBP coverage is required in the Judgment, the service member must submit an election within one year of divorce. The alternate payee should protect themself by submitting a “deemed election” within that time. Form DD 2656-10.
c) One question the parties should consider is if it is fair that the cost of the SBP comes off of the top of pension?
3. Active duty military pensions are divided with a coverture formula using years of service; but Reservist's pensions are calculated by points and dividing the pension using years of service would be unfair, usually to the service member.
4. Be aware that members may waive retired pay and take disability instead; the military will not make payments from disability pay. You may want to put in the MSA that if the pension is reduced because of disability payments, the alternate payee will receive an equivalent amount from the pension.

E. IRA accounts. They are not governed by ERISA so a QDRO is not required. The parties should be able to transfer them by a simple Letter of Direction. They do not need a separate court order.

II. Traps for the Unwary.

A. The forgotten Plan -- Many people have several plans. attorneys need to make sure to cover them all. As an example, virtually all Abbott employees participate in both the Annuity Retirement Plan which is a pension, and the Stock Retirement Plan which is a 401k plan. Most major corporations have both a pensions and a 401k. Small companies are likely to have only a 401k.
1. Many Illinois public sector employees choose to put money in a 457 plan – which is similar to a 401k plan and it can probably be divided with something similar to a QDRO.
2. Federal employees, both civilian and military personnel, can put money into a Thrift Savings Plan. The TSP can be divided with an order similar to a QDRO.
3. Many unions have both pensions and 401k plans – e.g., local electricians and plumbers unions have both.
4. Highly paid corporate executives may have several additional non-qualified plans.

An attorney must make sure she investigates the issue and refers to all retirement plans in the MSA.

Luckily, there may be a “Get Out of Jail Free Card” in cases where one or more retirement plans is accidentaly left out of the MSA: IRMO Hall, 935 N.E.2d 522, and IRMO Hendy, 949 N.E.2d 716. These two recent Second District cases state that MSAs are contracts and interpretation is a matter of contract law. The court is to try to ascertain the intent of the parties. Meaning that they can infer that the parties intended to divide all of the existing retirement plans, regardless of one not being listed. So an attorney can save herself future trouble by adding to the MSA a statement that the parties intend to divide the retirement accounts equally. Or ask the parties "Have you agreed to divide all marital retirement assets equally?" at the prove-up hearing.
B. Frozen Coverture -- Pensions are usually divided by a coverture formula or the Hunt formula. But you need to distinguish a coverture formula from a frozen coverture formula. The Alternate Payee probably wants to apply the coverture formula as of the date the Participant retires rather than at the date of the divorce. Abbott provides a model QDRO that is a frozen coverture formula. However, they will accept a regular coverture formula. I think an alternate payee’s attorney risks malpractice if they use the Abbott model QDRO. See IRMO Richardson, 884 N.E.2d 1246, a 2008 case in the materials. Richardson is interesting reading – both parties had actuaries and the court did a good job of explaining the difference between the two approaches. In that case the difference between the two formulas was $487 a month for the rest of the member’s life.

It is often hard to convince the pension plan member that the pension should be divided based on the value as of the time of retirement rather than as of the time of the divorce, but it is fair. At the time of the divorce, a valuation is just a hypothetical number with little connection to what the value will be at the time of retirement. The alternate payee can’t get their money at the time of the divorce – if the value is frozen, they lose the appreciation and accumulated interest until the time they can actually receive the money. And the participant would not receive the benefit of the highly paid final years without the less highly paid early years they shared with the alternate payee. In the end all of the years are compensated based on the final salary.

currently, Companies are converting pension plans. They are trying to get out of the pension funding liability. Motorola and FedEx, for example, are converting to what they call a “portable pension.” It is more like a 401K in that the member only receives the benefit that can be purchased with the contributions. The company is not funding a formula for payments. Older employees may have a pension that is a combination of both a classic pension and the new portable pension.

C. Mixed 401k – part of the 401k may be marital and part non-marital. If you have two litigious people, how are you going to figure out which is which? Say the participant had $100,000 in the 401k at time of the marriage 15 years ago. The Participant may argue that he gets the $100,000 plus any earning and appreciation on that amount. The plan probably can’t trace the earnings and appreciation on the initial amount and the Plan may have even changed fund managers several times during that time. Parties can hire an actuary to come up with an estimate of the appreciation. Or they can use a ratio of contributions pre-marital vs. marital. But, in the end, the contributions may be hard to trace. alternatively, they can divide it by a coverture formula using time. But I am not aware of any way to figure it exactly.

D. In the MSA don’t say ½ the pension if what is intended is ½ the marital portion of the pension.

III. Temper your Client’s Expectations

A. They need to do the QDRO as soon as possible.
1. It needs to be done before participant spouse dies. Otherwise the alternate payee is likely to get nothing. You can argue the plan should honor a nunc pro tunc order – but that is a hard sell, particularly where the plan probably gets to keep the money.
2. It should be done before the participant spouse retires – so the alternate payee isn’t in the position of trying to collect back benefits from the spouse.

B. Preparing a QDRO is going to cost some money. I can’t tell you the number of people that complain they did not understand that there would be additional expense after the divorce was finalized.

C. A QDRO is going to take time to implement. QDROs can help clients who are short on cash.
1. Normally there are only limited circumstances where the employee can cash in a 401k. Even if they are able to cash it in, they have to pay income tax at their marginal rate plus an additional 10% early withdrawal penalty. IRC section 72 waives early withdrawal penalty if alternate payee cashes out an award pursuant to a QDRO. The recipient still has to pay income tax, but it will probably at a lower tax rate than the participant. It is often attractive to agree to transfer the 401k to the non-employee spouse to cash out and pay the marital debts [and of course the attorneys].
2. Be sure to gross up the amount to withdraw to cover the taxes.
3. Not all 401ks will allow immediate withdrawal. Most will, but it is a good idea to verify.
4. The Alternate Payee probably won’t get the check for 3 or 4 months.

D. Do not provide in the Judgment that one attorney is going to represent both parties in preparing QDROs. It is a conflict of interest.