When dividing property and assets, the court will consider how pensions and retirement accounts will be divided between the spouses. In this podcast, listen to Alexandria divorce lawyer Carolyn Grimes on pensions and retirement accounts, as she helps individuals going through a divorce understand one of the most difficult – and complicated – aspects of the property division process. Listeners will learn about how benefits are divided, the role of QDROs, potential issues to watch out for, and more.
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Hosted by: Diana Shepherd, Editorial Director, Divorce Magazine
Guest speaker: Carolyn Grimes, Family Lawyer
Divorce lawyer and mediator Carolyn Grimes is a partner at the law firm Wade Grimes Friedman Sutter & Leischner PLLC. Named top attorney by Washingtonian Magazine in 2015, Grimes provides full-service family law representation throughout northern Virginia. By practicing law in a collaborative model, she is dedicated to helping her clients resolve issues amicably. Learn more about Grimes and her firm by visiting www.oldtownlawyers.com.
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Read the Transcript of this Podcast Below.
Carolyn Grimes on Pensions and Retirement Accounts
Diana Shepherd: What is the difference between a defined benefit and a defined contribution pension plan?
Carolyn Grimes: These retirement benefits are for private sector employment. There is a federal law called the Employee Retirement Income Security Act (ERISA) that governs private pensions and 401(k) plans and other employer provided retirement plans.
If you work for corporations like IBM or Hewlett Packard, this law is what applies to you. A defined benefit plan is what people typically think of as a pension. It is an amount of money that is paid to you every month when you retire.
Defined benefit means, in structuring the plan, the company decides the benefits they want to pay at the end. The company will decide, for example, that they want a pension plan that pays employees who make $80,000 a year $2,000 a month when they retire. That’s what a Defined Benefit Plan is, and then it’s funded either by employer contributions only or employee contributions.
A defined contribution plan is a plan in which the employer determines the amount of the contribution deposited into the plan, not the benefit received at retirement. A 401(k) is a typical defined contribution plan. With these plans, there are typically employee contributions and employer matches for contributions. The growth or decline on the money contributed to the plans are the results of the investment experience of the contributions.
What’s the difference between an Individual Retirement Account and a Qualified Pension Plan?
Individual Retirement Accounts are retirement accounts that people contribute to that are not connected with their employment at all. They’re only in one person’s name. Clients often say that they both have an IRA, but that’s not true. Individual Retirement Accounts are in one person’s name.
Each party can have an IRA and marital money can go into an IRA in one person’s name, but it’s only in one party’s name. A Qualified Pension Plan is something that comes from your employer. These are two different things. The IRAs are not governed by ERISA – the law that governs the employment retirement benefits. IRAs are basically governed by the IRS Tax Code for tax deductible contributions. They are divided not with special court orders but with your final divorce decree and generally a form from your financial house that both parties have to fill out.
Are there any penalties or taxes to be aware of in dividing a pension?
One of the key features of ERISA and all the statutes that govern the division of retirement assets is to protect the tax treatment of the retirement assets. Retirement assets are basically tax-deferred money. It is money that you receive now but that you put away now and you are not taxed on and you are not taxed on the growth on it as it sits in your account. The big benefit of retirement accounts is the tax deferred growth on it.
In order to divide an IRA, you have to be divorced and usually you have to present your final divorce decree. There’s a form that needs to be filled out from the financial house Fidelity, Transamerica, whoever holds your IRA,which you have to sign part of it and it has to be rolled over into your ex-spouse’s IRA. You can’t take the money out directly and pay him or her because then you’ll be taxed on the withdrawal.
Withdrawals from IRAs are taxable and if you are younger than 59.5 years old, there is an additional 10% tax penalty. If you withdraw money instead of rolling it over to your ex spouse, you will be taxed on the withdrawal, not your spouse. So direct rollover is a law of the land now. Direct Rollover is better. You just roll over from one to the other. You’re not taxed; they are not taxed. When you divide the pension by the special court orders that apply, there is no tax at the moment of transfer for the transfer, if you withdraw the money after the rollovers, you will be taxed.
There are traditional IRAs and Roth IRAs, the difference being in a Roth, the contributions are not tax deductible, so when you take the money out in retirement, you are not taxed as it comes out. There are various income and contribution limit which govern who can be eligible for a ROTH or regular IRA.
How are pensions typically divided on divorce in Virginia?
A pension is typically divided by a formula called the Marital Coverture Fraction, which sounds really scary but it’s really simple. The numerator is the time on the job during the marriage divided by the total time on the job times 50%,typically and that percentage yielded by the formula is applied to the pension when received, so each party receives one half of the marital share of the pension.
When there is a cost-of-living increase, a COLA, on the pension because the former spouse has a percentage share, they get a percentage share of the cost-of-living increase, too. That’s a pretty common way to divide pensions.
When dividing pensions during a divorce, what are the most common errors to look out for?
The first most common error is that people don’t realize they have a pension. It used to be that lots of people had pensions in the private sector, but honestly, once IBM took away its pension plan and converted it to a 401(k), most of the big companies stopped having pension plans. The phone companies still do. GE does. Lockheed Martin does. Often people don’t know their own retirement benefits, so start out by looking at the pay stub. If you’re contributing to a retirement account, you need to find out if it’s a 401(k) or a pension. On a W2, you won’t necessarily see a deduction, but the box marked “retirement plan” will be checked, and that means generally that there is a pension. You need to look for the pension, first of all.
You need to try to obtain the plan documents and see what the pension allows for before you sign the agreement. You also need to have the correct dates of service. Sometimes people work for a company prior to a marriage, so they have pension credits that have accrued prior to the marriage. It’s only the marital share that is generally subject to division.
You need to know the dates of employment for everyone, both sides, and when the pension started. Also, sometimes pension credits don’t start accruing until you work for a company for a while. You have to make sure you adjust the formula division for that. There is also generally survivor benefits available on pensions which is an amount of money that is paid to the spouse once the employee dies.
Make sure you determine if you want a survivor benefit because there is a cost to have one. For a long-term marriage, spouses generally have a large share of the other spouse’s pension, so generally want a survivor benefit, but you have to pay for it. The Survivor Benefit Premium is generally deducted from the pension at the time it’s paid, not before. It’s subject to negotiation between the parties as to who pays for it, whether it comes off the top – which basically means everybody pays a share of it – or whether it’s allocated just to the spouse who is receiving the survivor benefit, which most private pensions will allow you to do.
What is a Qualified Domestic Relations Order (QDRO) and how and when is it used?
The Qualified Domestic Relations Order is the court order that ERISA created to allow private pensions to be divided by state court. It’s an order that’s entered by the divorce court and then sent to the plan administrator of the pension or the 401(k) plan to allow the retirement assets to be divided. The employers are bound to follow the court orders.
Retirement assets are generally not subject to garnishment by creditors. If you sue someone, you can’t get their retirement asset. What a QDRO technically is, is an order that’s an exception to the garnishment statute. All a QDRO really is, is a garnishment order. It allows the former spouse to get paid what they’re due. QDROs can also be used to garnish retirement income for child support and spousal support and arrearages in child and spousal support.
The federal law provides for that. Virginia had a case that said you couldn’t use it that way for a number of years, but that has been overturned by another case – which was my case – and also by the garnishment code, which has since been amended to allow QDROs to be used to collect child and spousal support arrearages. That’s a federal law, so that is able to be done in every state, not just in Virginia.
The practitioners may not be familiar with the use of QDROs to collect support. It’s rare that you use it, but it is there and available, and that’s another good use of QDROs besides dividing pensions and retirement.
Let’s say the court has ordered that a QDRO should be drafted to give the ex-spouse half of the marital portion of the pension as a lump sum. After the divorce is final, the ex-spouse discovers that the plan doesn’t pay lump sums. Does this mean that the ex-spouse loses his or her benefits? If so, how do you protect your clients from this sort of issue?
Well, this can happen. Let’s take one example where you have a property settlement agreement and you’ve drafted it saying that your client should get the lump sum. You didn’t check to make sure whether or not the lump sum could be gotten, or you were given the information that it could have and that turns out to be erroneous. In the drafting, the way you protect your client is to provide an alternative.
If the plan does not allow lump sum, generally the alternative is the payments that the plan does allow. A QDRO can’t be in effect to order the plan to pay benefits other than the way the plan is set up to pay benefits. You can’t force them to give a lump sum. If you’re going to take an unusual distribution, and a lump sum is pretty unusual, always provide an alternative in your drafting.
The other example is, let’s say the court has ordered a lump sum. There is no agreement. You didn’t have any way to protect your client in advance. The court had then ordered something that can’t be done because the plan says, “No, I won’t pay it that way.” In Virginia, what you would do is go back to the judge and say, “Your honor, we need to modify the payment terms of your order,” because here you can’t modify a final decree once it’s been entered but you can address issues and enforcement. Whether or not you can be protected in that way depends on how your state law handles those types of issues.
It’s a federal law, so the law that the plan is not allowed to pay benefits in a way that aren’t in its plan trumps a state order. The remedy in the state court is going to vary by state. What probably most practitioners should do if a court is ordering a lump sum is ask the court at the time that it’s being ordered, that if the plan doesn’t honor the lump sum, an alternate payment is put into effect then.
What happens if the plan participant dies after the parties are divorced but the QDRO hasn’t been drafted yet?
What happens is a lot of bad things, essentially. This is a huge problem in divorce cases when it occurs. There is an odd Virginia case that popped up recently where the parties didn’t finish the QDRO for 17 years after the divorce and the ex-husband died. He was remarried to someone else, so his new wife is his beneficiary under federal law, and she said, “No I get that money.” They had a very unusual term in their agreement that the retirement benefits will go to the children – not the ex-spouse – which is odd. I really recommend against that.
The ex-wife prevailed and the court entered the QDRO, even though the husband was dead, submitted to the plan but the plan basically kicked it back and said, “I can’t pay this. I don’t know what you want me to do. I have a current wife on record who should receive the benefits.”
The result was that a Virginia Court of Appeals decision said you could enter, basically, a posthumous QDRO under a very odd quirk of the law because it was a 401(k) plan, not a pension, but that case has also gone now to the Federal Circuit. The Federal Circuit has said, “No, you can’t do that.” The key moral of this story is get the QDROs entered as soon as you get divorced. Get them to the plan administrator immediately, because the longer you wait the greater the chance you have of something bizarre happening. Then it takes a lot of litigation to try to unwind it, and you may not be able to fix it.
Can someone qualify for Social Security retirement benefits based on the earnings of his or her ex-spouse?
Yes, Social Security benefits are not divisible in divorce. They’re not a property asset, but what happens when you go to apply for Social Security at retirement age, they generally ask you to fill out an enormous form that asks you who you’ve been married to amoung other things. If you have been married to someone for 10 years or more and you would get a higher social security benefit claiming as that person’s spouse – you don’t have to be married to them at the time you’re applying – then you get a bump up in your social security benefits. You’re not taking anything from your ex-spouse. This is a part of Social Security that’s designed to protect non-working wives from way back when. It’s essentially the wife benefit bump up, although men can get it, too. It’s not gender designated, but that’s what it’s for. If you’ve been married to someone for 10 years or more and have a lower social security benefit claiming under your own wages, then you can obtain a bump up in your Social Security based on the credits of having been married to that person.
If both spouses have their own IRAs, do they still need to be valued and divided?
Typically, and in Virginia especially, all marital assets are looked at regardless of whose name they are in. If the wife has an IRA of $20,000 and the husband has an IRA of $10,000, our courts will generally, and people also generally agree to, equalize them so that they each end up with $15,000, which would require a rollover from the wife to the husband of $5,000 in the IRA. Typically yes, there are all marital assets.