Qualified Domestic Relations Orders
Pension funds are the crucial third leg in the retirement income security stool, along with savings and Social Security. A professional's error in dividing pension assets after a divorce can cripple a family's ability to survive at retirement when they most need the money they've been counting on their entire lives. Unfortunately, practitioners are either making mistakes or playing games with the system. This problem presents serious challenges for attorneys and individuals undergoing divorce who are unfamiliar with either family law or the federal law governing pension plans and retirement benefits.
This article examines one example of why family law and employee benefit practitioners must work together, but there are literally hundreds of pitfalls into which unsuspecting attorneys and parties to a divorce might fall without the experts necessary to avoid them. Absent a legislative solution, both types of specialists - family law and employee benefit attorneys - must work in concert to ensure adequate protection for their clients.
A Qualified Domestic Relations Order ("QDRO") is a court order instructing the pension plan administrator as to how to divide plan benefits. A plan administrator processes pension benefit claims when people retire much in the way a human resource department in a company processes payroll.
Normally arising in the context of divorce, QDROs are the plan administrator's guide as to how much of a pension benefit the employee is entitled to upon retirement, as well as how much his or her former spouse is to receive when he or she becomes eligible for a benefit. Unfortunately, due to their complex nature, QDROs present a problem for many practitioners unfamiliar with the laws that created QDROs, the Employee Retirement Income Security Act ("ERISA") of 1974, 29 U.S.C. § 1001 et seq., and the Internal Revenue Code ("IRC").
For readers who are not attorneys, family law attorneys handle divorce cases based on the law of the state in which they practice. These divorce-related laws are different in every state. By comparison, ERISA is a federal law which applies to the entire country and is completely separate and distinct from state-based divorce laws.
When people divorce, they often need to divide the right to the former spouse's pension plan through the use of a QDRO, which is a court document that explains how the pension is to be divided. As QDROs are often necessitated by divorce, you need expertise in ERISA in order to properly execute a QDRO. However, ERISA work is a unique specialty when it comes to the practice of law, and most divorce lawyers have little or no experience with it. Likewise, just as most family law practitioners are out of their element with ERISA, most employee benefit practitioners are equally inexperienced with family law.
Hence the problem - both areas of law are specialties with which practitioners of either have little contact, yet both require familiarity with the other to adequately evaluate and process a QDRO. This unusual confluence of specialties creates a dilemma for practitioners of both types of legal practice. Neither knows much about what the other does for a living, yet they both need to blend their skills to produce a QDRO that protects their clients' interest in pension benefits.
The retirement income security of an unknown number of American workers and families depends unwittingly on practitioners' with little understanding of each others' industries successful efforts to create equitable and compliant QDROs.
One actual example of why it is prudent to contact an employee benefits attorney to review a QDRO is the recent spate of "one-sided" QDROs we are seeing. For the purposes of a QDRO, the parties to a divorce are the Participant (the person who is in the pension plan), and the Alternate Payee (the spouse who wants a percentage of the Participant's pension plan benefit).
In one instance, a woman who previously obtained a divorce was attempting to get a portion of her husband's defined contribution account that both the husband and his employer were contributing to; i.e. his 401(k). The divorce occurred in 1998, and we received the QDRO in 2002. Her attorney sent us a proposed QDRO stating that the wife - the Alternate Payee in QDRO parlance - was entitled to: "division of the individual account as of the date of divorce." The markets you recall were quite high back in 1998, and correspondingly lower in 2002.
We represented the husband and we checked the underlying divorce decree to see if it stated what the proposed QDRO they sent us stated. It did not, and the difference between the divorce decree and the proposed QDRO was critical. It clearly indicated that the woman as Alternate Payee was entitled to "division of the individual account as of the date of divorce, plus such gains and losses as occur from the date of divorce through the date of division." The language in italics is crucial. The fact that it had been excluded from the QDRO would have been downright disastrous had we not caught it.
Here's why. At the time of their divorce in 1998, the husband-Participant had approximately $ 200,000.00 in his 401(k) account. As a result of diminished investments, by the date of division in 2002, that $200,000.00 had decreased to $150,000.00. If, as the wife-Alternate Payee's lawyer suggested, we used the 1998 date of divorce as the date of division of the account, the wife would have received $ 100,000.00, and our client would have been left with $ 50,000.00.
Pursuant to the decree, however, he should get $75,000.00 - one half of the $ 150,000.00 - not $ 50,000.00. He would have experienced a $25,000.00 loss if we hadn't identified the problem.
After we rejected their deficient language and requested a corrected provision including post-divorce gains and losses, both parties received $75,000.00 in their two separate accounts. They both now have independent exposure to risk, over which they can freely exercise their own discretion in terms of risk levels from this point forward. Clearly, the proposed QDRO language was an attempt, unfairly in our view, to extract financial gain while causing significant damage to our client.
Our feeling on this type of practitioners' conduct - be it inadvertent or intentional - is that both parties should always share the gains and losses unless both parties were clearly advised as to the ramifications of electing to risk predicting the market with a provision like the one at issue.
Parties are free to gamble if they wish, but practitioners have a duty to warn people about the potential impact of documents which could seriously harm their financial future. After all, in our example, if the market had thrived between 1998 and 2002 and there was, hypothetically, some $300,000.00 in his account in 2002, the Alternate Payee in our example would have received $ 100,000.00 and he $ 200,000.00.
No one knows what the market will do, and provisions whose effect it is to "game" the market introduces inherent risk to both parties - one party will definitely be hurt; the other party will definitely benefit; and there's no way to tell in advance which will be which. On the other hand, if they share equal risk of gains and losses, then both parties can be secure right up front that each will get that portion of the pension benefit to which he or she is rightfully entitled.
For those that would assert caveat emptor - let the buyer beware - bear in mind that both parties can still freely elect to make independent decisions to invest in as risky or as risk averse portfolios as they wish. They can gamble to their heart's content, so long as they do it separately once their own, independent, accounts are created. We wouldn't advise that, of course; we'd advise them to contact a qualified investment professional.
In our opinion, practitioners should not be permitted to accidentally or arbitrarily reduce or entirely eliminate someone's pension benefit, either because they made a mistake by failing to identify and correct a provision that excludes earnings and losses, or because they intentionally attempted to carve out market losses (or carve in market gains) with a provision in a divorce decree or QDRO as the practitioner in our example attempted to do.
Bear in mind, also, that many errors and omissions in QDROs are not really the fault of the family law practitioners and employee benefit lawyers who commit or omit them. The legislature created ERISA without family law in mind. Consequently, there are fundamental flaws in the way state family laws and ERISA integrate. The result is provisions being written into documents that can cause adverse consequences that even the best practitioners may miss. That's the problem. The existing system for dividing pension plan interests is inherently prone to errors, omissions, and game playing.
We can use an extreme version of the same example to illustrate how absurd and dangerous this particular loophole really is. Assume that a hypothetical married participant age 51 in 401(k) plan had $100,000.00 in her account as of January 1, 2003. Her husband later seeks a divorce and they're separated on January 1, 2004. The husband hires a good family law attorney who knows a good employee benefit practitioner and they manage to get her and her family law attorney (who didn't know a good employee benefit practitioner) to sign a divorce decree effective January 1, 2005. The decree is silent on the issue of whether earnings and losses are to be attributable to either party.
Two years later, on January 1, 2007, the QDRO is signed and states that the former husband, the Alternate Payee for ERISA purposes, is entitled to: "fifty percent of the 401(k) account balance as of the date of divorce." Legally, that's perfectly permissible because the parties may negotiate freely.
While all this was going on, her investments fluctuated considerably. Her account was up to $ 150,000.00 as of January 1, 2005 but decreased to $50,000.00 as of January 1, 2007. Based on these documents, he is entitled to 50% of whatever was in her account January 1, 2005. As there was $150,000.00 in her account on that date, he is entitled to $75,000.00.
Unfortunately, her account has a balance of only $50,000.00, and the plan administrator has no obligation to pay the other $ 25,000.00 to make up the difference. Consequently, the plan administrator would have to pay him all $ 50,000.00, leaving her with absolutely nothing. He would also have an independent claim against her for an additional $25,000.00.
On her part, she will have little or no defense when he files a complaint against her to collect his $ 25,000.00, and she will also have no claim against the plan. All she will have is a malpractice action against her attorney and few resources with which to fight it - a poor substitute for Congress' vision of the process by which pension plan benefits are to be divided.
That a person could lose their hard-earned pension benefits so easily, and be bankrupted in litigation to boot (depending on the individual) is disconcerting to say the least. Unfortunately, that's the reality of the QDRO system as it stands today. This absurd scenario is likely happening at this moment, unwittingly or otherwise, all across the country.
The loophole creates room for errors, omissions and game playing in an area where people are most vulnerable. It is well known that over the last ten years, as employers looked for ways to minimize exposure, billions of dollars shifted from the more secure defined benefit plans (where the employer has the responsibility and risk) to defined contribution plans (where employees bear the responsibility and the risk for ensuring fiscal stability). Americans have more than $1.75 trillion invested in 401(k) plans alone.
In this context, with an aging population placing more and more of burden on the government to ensure solvent retirement resources, and employers placing more obligations on employees to endure the risk, there's no telling what a problem like the one in my example could cause nationally. It's impossible to know how many QDROs are lying dormant in the offices of plan administrators around the country, just waiting for people to discover that they've got dramatically less in available pension funds than they anticipated. Just based on how many times the issue arose in this office, it must be a considerable number.
Many participants and alternate payees, as well as many lawyers, simply cannot independently discover, or in some cases understand, this potentially grave problem. Until Congress does something about it, everyone involved in the division of household assets in divorce situations should be diligent about watching out for all potential QDRO problems, not the least of which is the "earnings and losses" language. At this juncture, we're under the impression that Congress isn't even aware of the problem so it could be quite some time before any legislative intervention could - or would - occur.
The Plan has no duty to inform Participants or Alternate Payees or their attorneys, either, when the plan's attorney or administrator sees a potential problem. The parties are free to negotiate as they wish without intervention by the plan. Consequently, until the legislature steps in to abolish hyper-technical errors, and fundamentally inequitable divorce decree and QDRO provisions that can lead to unanticipated impoverishment at retirement, the family lawyer and employee benefit specialist are the last line of defense for an aging population.
This combination of factors is a recipe for creating harms that won't arise until years later, often at retirement, when it is likely too late to correct errors made many years before.
THE (ONLY AVAILABLE) SOLUTION
As it stands now, individual attorneys who deal with QDROs on a daily basis are in effect de facto legislators, executors and judges. They essentially control pension policy in the United States in many divorce situations. Due to the disjointed statutory integration of ERISA and state family and ethics laws, individual attorneys are the ones deciding, on a case-by-case basis, be it by savvy or error, whether parties to divorce get their defined contribution pensions or not, and if so to what degree. In our opinion, that is a very unfortunate reality for millions of Americans nationwide.
Absent a legislative solution, however, the only real option is to contact the professionals who know the most about pension plans. If you do decide to do so, it is crucial that you do so before finalizing the divorce decree, well in advance of the QDRO. This is true because irreconciliable damage can be done in the decree which an employee benefits attorney may not be able to correct in the QDRO.
 Those advocates who suggest that a participant's control over the entire individual account from the period of separation until the date the QDRO is finalized, which can often take years, gives the participant the exclusive power to manage risk adverse to the interest of the alternate payee, fail to account for the fact that participants have as strong an interest in successful investment performance as alternate payee's do. Ideally, in our opinion, all spouses would have an inalienable and unassignable wholly separate individual account from the date of marriage, or as soon after marriage that an account is created, through the date of each party's respective death.