What The Heck is a QDRO?
The short answer is that it is a Qualified Domestic Relations Order, however, QDRO (pronounced KWAH dro) is a quick and easy abbreviation. No matter how you say it, this Order is used to document and execute future distributions of retirement benefits after a divorce. For those of you who like details or just want to have a better understanding of the process used to divide different types of retirement benefits, read on for the long answer.
For parties involved in divorce proceedings who have within their marital estate retirement benefits, the division of those benefits is often confusing and may require special court orders to divide. In order to determine what is necessary to divide a retirement account, some basic principles need to be understood. What type of account is being divided and how was it funded? First, there are qualified accounts and non-qualified accounts. A qualified retirement account is one in which the monies that funded that account were not taxed before being placed into the account. These pre-tax funded accounts are qualified because the tax on the monies is deferred until paid out presumably post-retirement age. Qualified accounts include 401(k) and 403(b) plans, certain IRA plans, and the like. The account is funded with pre-tax dollars, which saves taxes during working years.
If a retirement account needs to be divided in a divorce and that retirement account was funded with qualified money, it cannot be liquidated for an immediate distribution of cash to a party without tax ramifications and often penalties. So, that account is not divided immediately and instead is deferred to a later date. That future distribution must be quantified and documented for the future. The way it is documented is via a Qualified Domestic Relations Order. A QDRO will identify the owner of the retirement account or “Participant” and the other party who will be receiving a portion of that retirement account, the “Alternate Payee”. The QDRO will indicate either a percentage of the account or an amount to be distributed to the Alternate Payee and should define whether the amount or percentage to be awarded to the Alternate Payee should include gains and losses on the amount to be awarded pending the division of the Participant’s account into an account in the name of the Alternate Payee alone. The Plan Administrator for the retirement account determines how QDROs must be prepared, what happens under certain circumstances pending a Participant or Alternate Payee reaching the age at which they can begin receiving benefits, along with other requirements. It is important to ensure that a QDRO is prepared correctly, approved by a Plan Administrator, approved by the court, and then provided to the Plan Administrator for future use at the time when a party intends to begin receiving distributions from the retirement account.
Non-qualified accounts, or accounts that are funded by post-tax dollars, are much easier to divide. They are often akin to dividing savings accounts. For example, a Roth IRA is funded with monies that have already been taxed and as such, when distributions are taken from a Roth IRA, those dollars are not taxed, but for any gains on the initial investments. Often a Roth IRA or other non-qualified accounts can be transferred via internal transfer paperwork with the Plan Administrator as opposed to having a QDRO prepared.
In addition to qualified and non-qualified retirement accounts, some individuals still have traditional pensions. IRA, 401(k), 403(b) plans, and the like are what are called “Defined Contribution Plans” because a specific defined amount of money is placed into the accounts at particular intervals and in some circumstances, matched with employer contributions as well. Pensions are “Defined Benefit Plans” which means that a particular benefit amount is awarded at the time of retirement based on several factors including years of service, average pay rates over particular periods of time, cost of living increases, etc. Defined Benefit Plans like pensions require a QDRO to divide them in a divorce setting and often have very different Plan requirements that affect the value and distribution of benefits when a party begins receiving them.
When valuing a marital estate, Defined Contribution Plans are relatively easy to value because Plan statements are received showing the total value of the account each month or quarter. However, Defined Benefit Plans, or pensions, must be valued using an actuarial calculation whereby the estimated monthly benefit that an individual is to receive at their future retirement date must be calculated to a present value. Often attorneys utilize actuarial professionals to perform the calculation of a present value of a pension so that such value can be used to offset other assets to be divided in the marital estate.
So if you’re still awake, you’ve probably concluded that division of retirement benefits, whatever the form, can be complex and require expertise in order to ensure that the valuation, division, and paperwork necessary to effectuate the same is done correctly. When reviewing the value and potential distribution of a retirement account, parties should ask questions and understand the different accounts, the specific Plan provisions for the accounts to be divided, and when those monies can be available in the future. These details should always be discussed with your divorce attorney.