If you are an employee benefits administrator, you will likely face situations when an employee in the process of getting a divorce informs you a court will be issuing a Qualified Domestic Relations Order (QDRO). Prepare yourself for this eventuality.
A QDRO primarily establishes a spouse’s or ex-spouse’s legal right to receive a designated percentage of a retirement account balance, or certain retirement benefit payments. Because it is a court order, you must make sure you follow it to the letter. Not only do you have an obligation to discharge your obligations under the QDRO, but you also have a fiduciary responsibility under the Employee Retirement Income Security Act (ERISA). Here are eight important steps to take.
1. Provide the Alternate Payee (ex-spouse) information on the retirement plan.
Allow access to plan and participant benefit information sufficient to prepare a QDRO. Such information might include the summary plan description, relevant plan documents, and a statement of the participant’s benefit entitlements. You may condition disclosure of such information on a prospective alternate payee’s providing information sufficient to reasonably establish the disclosure request is being made in connection with a domestic relations proceeding. Affording prospective alternate payees access to plan and participant information in a timely manner will help drafters avoid making obvious errors in preparing orders and, thereby, facilitate plan administration.
2. After receiving the proposed QDRO, notify those involved.Promptly notify the affected participant and each alternate payee named in the order and provide a copy of the plan’s procedures for determining whether a domestic relations order is a QDRO. Notification should be sent to the address included in the domestic relations order.
3. Establish procedures to determine if the order is a QDRO.
Establish written procedures for determining whether domestic relations orders are QDROs and for administering distributions under QDROs.
4. Outline the proper procedures.
The QDRO procedures must:
- Be in writing;
- Be reasonable;
- Provide that each person specified in a domestic relations order received by the plan as entitled to payment of benefits under the plan will be notified (at the address specified in the domestic relations order) of the plan’s procedures for making QDRO determinations upon receipt of a domestic relations order, and
- Permit an alternate payee to designate a representative for receipt of copies of notices and plan information sent to the alternate payee with respect to a domestic relations order.
5. Keep track of expenses.
An administrator may assess reasonable expenses attributable to a QDRO determination against the individual account of the participant who is a party to the domestic relations order. The documents of the plan should be reviewed to determine how plan expenses are allocated.
6. Make a determination in a reasonable period of time.
You must determine whether a domestic relations order is a QDRO within a reasonable period of time after receiving the order. What is “reasonable” will depend on the specific circumstances. For example, a domestic relations order which is clear and complete when submitted should require less time to review than an order that is incomplete or unclear.
7. Separately account for the amounts payable to the alternate payee.
During any period in which the issue of whether a domestic relations order is a QDRO is being determined, ERISA requires the plan administrator to separately account for the amounts which would be payable to an alternate payee under the terms of the order during such period if the order had been determined to be qualified. You must take steps to ensure amounts which would have been payable to the alternate payee, if the order were a QDRO, are not distributed to the participant or any other person.
The plan administrator’s duty to separately account for and to preserve the segregated amounts is limited in time. ERISA requires the plan administrator to preserve the segregated amounts for not longer than the end of an “18-month period.”
8. Provide notice of your determination.
The plan administrator must notify the participant and each alternate payee of the administrator’s determination as to whether the order constitutes a QDRO. This notice should be in writing and furnished promptly following a determination.
In the case of a determination that an order is not qualified, the notice should include the reasons for the rejection. The notice of the plan administrator’s determination should be written in a manner which can be understood by the parties. Multiple submissions and unnecessary expenses may be avoided by clearly communicating in the rejection notice:
- The reasons why the order is not a QDRO;
- References to the plan provisions on which the plan administrator’s determination is based;
- An explanation of any time limits which apply to rights available to the parties under the plan (such as the duration of any protective actions the plan administrator will take); and
- A description of any additional material, information, or modifications necessary for the order to be a QDRO and an explanation of why such material, information, or modifications are necessary.
These are only some of the steps a benefits administrator must take in this situation. Contact your employees benefits consultant or your attorney to ensure you are fully complying with the proper procedures relating to a QDRO.
Here’s an important reminder for those who want to max out before-tax contributions to employer-sponsored salary retirement plans, which include 401(k), 403(b), 457 and SIMPLE plans, as well as traditional and Roth IRAs. If you are age 50 or older at the end of this year, you are generally eligible to make “catch-up” contributions for the current tax year.
You also have until the due date of last year’s tax return (April 15 or, if it falls on a weekend, the next business day) to make IRA catch-up contributions for that year. In other words, you can make contributions for the 2017 tax year right up to April 15, 2018 (or the next business day if the 15th falls on a weekend). These contributions are above and beyond the regular contribution limits listed in the right-hand box that apply to salary reduction plans and IRAs.
Why should you make catch-up contributions? Because studies show that many Americans have not been saving enough for retirement. This shortfall becomes more critical as retirement age approaches. Extra contributions are intended as a tax incentive to spur people to make up the difference while they can.
Here is a table of the catch-up contributions currently scheduled:
How Much of a Difference Can Catch-Up Contributions Really Make?
Good question. To find the answer, let’s assume that you turned 50 in 2005 (when the limits for employer-sponsored salary reduction 401(k), 403(b), or 457 plans were $14,000 and $4,000 for catch-up contributions) and take full advantage of the maximum contributions allowed for 2005 and the following 15 years. The analysis below shows how much extra you could accumulate by age 65.
The next analysis shows how much extra you could accumulate in your IRA by age 65, assuming you turned 50 in 2005 and make maximum catch-up contributions starting with the 2005 tax year (when the limits were $4,000 plus $500 catch-up) and continuing for the following 15 years.
The final analysis shows how much extra you could accumulate by making salary deferral catch-up contributions plus IRA catch-up contributions, assuming you turned 50 in 2005 and make maximum catch-up contributions starting with the 2005 tax year and continuing for the subsequent 15 years.
Anyway you look at it, that’s a lot of extra money. If you are married, your spouse can make catch-up contributions (if eligible), and double these amounts.
The IRS cautions plan administrators that they must document and keep necessary records of all employees’ hardship distributions and plan loans. The result of noncompliance could be a qualification failure for the plan.
Basic information. In general, a retirement plan can make a hardship distribution only:
- If the plan permits such distributions; and
- Because of an immediate and heavy financial need of the employee. In this case, the distribution should only be an amount necessary to meet the financial need.
Hardship distributions are generally subject to income tax in the year of distribution. And, if the employee is under age 59 1/2, the distribution is subject to the 10 percent early distribution tax unless some exception to this early distribution tax applies. However, hardship distributions aren’t subject to mandatory 20 percent income tax withholding.
In general, the question of whether an employee has an immediate and heavy financial need is based on the relevant facts and circumstances. Under IRS regulations, a distribution is treated as made on account of an immediate and heavy financial need if it is made for:
- Expenses for (or necessary to obtain) medical care that would be deductible under tax law, including expenses for the care of a spouse or dependent.
- Costs directly related to the purchase of a principal residence for the employee (excluding mortgage payments).
- Payment of tuition, related education fees, and room and board expenses, for up to the next 12 months of post-secondary education for the employee, the employee’s spouse, children or dependents.
- Payments necessary to prevent the employee’s eviction from a principal residence or foreclosure on the mortgage on the residence.
- Payments for burial or funeral expenses for the employee’s deceased parent, spouse, children or dependents.
- Expenses for the repair of damage to the employee’s principal residence that would qualify for the casualty tax deduction.
Under IRS guidance, a 401(k) plan that permits hardship distributions of elective contributions to a participant only for expenses described above may permit distributions for medical, tuition and funeral expenses for a primary beneficiary under the plan. A “primary beneficiary” is someone named as a beneficiary under the plan who has an unconditional right to all (or part) of the participant’s account balance upon the participant’s death.
A distribution won’t be treated as necessary to satisfy an employee’s immediate and heavy financial need to the extent it exceeds the amount required to relieve that need, or the need can be satisfied from other resources that are reasonably available to the employee.
Unless an employer has actual knowledge to the contrary, it may rely on an employee’s written representation that his or her immediate and heavy financial need can’t reasonably be relieved:
- Through reimbursement or compensation by insurance or otherwise;
- By liquidating assets;
- By stopping elective contributions or employee plan contributions; or
- By other distributions or nontaxable loans from employer plans or by any other employer, or by borrowing from commercial sources on reasonable commercial terms.
A hardship distribution can’t exceed the “maximum distributable amount.” In general, this amount includes the employee’s total elective contributions on the distribution date, reduced by any previous distributions of elective contributions.
Get and Keep Records
In its Employee Plans News, the IRS states that failure to have hardship distribution records available for examination is a qualification failure that should be corrected using the Employee Plans Compliance Resolution System (EPCRS).
The IRS tells plan sponsors to retain the following records in paper or electronic format:
- Documentation of the hardship request, review and approval;
- Financial information and documentation that substantiates the employee’s immediate, heavy financial need;
- Documentation to support that the hardship distribution was properly made in accordance with the applicable plan provisions and the Internal Revenue Code; and
- Proof of the actual distribution made and related Forms 1099-R.
It’s not enough for plan participants to keep their own hardship distribution records, the IRS cautions, because they may leave employment or fail to keep copies of documentation, which would make their records inaccessible in an IRS audit.
Also, electronic self-certification is not sufficient documentation of the nature of a participant’s hardship. IRS audits show that some third-party plan administrators allow participants to electronically self-certify that they satisfy the criteria to receive a hardship distribution. While self-certification is permitted to show that a distribution was the sole way to alleviate a hardship, the IRS reminds plan sponsors that self-certification is not allowed to show the nature of a hardship. Plan sponsors must request and retain additional documentation to show the nature of the hardship.
Basic information. A loan to a participant in a qualified employer plan won’t be treated as a deemed (taxable) distribution if it satisfies certain amounts, terms, repayment and documentation requirements. A plan loan amount can’t exceed the lesser of: $50,000, or one-half of the present value of the employee’s nonforfeitable accrued benefit under the plan.
But a loan up to $10,000 may be allowed based on the plan’s provisions, even if it’s more than half the employee’s accrued benefit.
If a plan loan (when added to the employee’s outstanding balance of all other plan loans) exceeds these limits, the excess is treated (and taxed) as a plan distribution.
A participant may have more than one outstanding plan loan at a time. However, any new loan, when added to the outstanding balance of all of the participant’s plan loans, can’t exceed the plan maximum amount.
In determining the plan maximum amount, the $50,000 ceiling is reduced by the difference between the highest outstanding balance of all the participant’s loans during the 12-month period ending on the day before the new loan and the outstanding balance of the participant’s loans from the plan on the new loan date.
A plan loan generally must be repaid within five years in substantially level payments, made not less frequently than quarterly, over the term of the loan. The five-year repayment limit doesn’t apply to a loan used to buy a dwelling unit which, within a reasonable amount of time, is to be used as the participant’s principal residence. In general, refinancing can’t qualify as a principal residence plan loan. The plan loan must be evidenced by a legally enforceable written agreement with terms that demonstrate compliance with the requirements for nondistribution treatment, specifying the amount and date of the loan, and the repayment schedule.
What to Keep
The IRS tells plan sponsors to retain the following records, in paper or electronic format, for each plan loan granted to a participant:
- Evidence of the loan application, review and approval process;
- An executed plan loan note;
- If applicable, documentation verifying that the loan proceeds were used to purchase or construct a primary residence;
- Evidence of loan repayments; and
- Evidence of collection activities associated with loans in default and the related Forms 1099-R, if applicable.
If a participant asks for a loan with a repayment period in excess of five years to buy or build a primary residence, the plan sponsor must obtain documentation of the home purchase before the loan is approved. IRS audits have found that some plan administrators impermissibly allowed participants to self-certify eligibility for these loans.
If your company sponsors a retirement plan, you — or your appointees — are the plan fiduciaries charged with making responsible decisions under the law. According to the Labor Department, fiduciaries must “carry out their responsibilities prudently and solely in the interest of the plan’s participants and beneficiaries.”
In order to monitor your company’s retirement plan, you need to be aware of the type of fees charged and ensure they are reasonable. Common fees include:
Plan administration fees, necessary to pay for the day-to-day operation of a plan. They include legal trustee, bookkeeping and accounting services. These fees may be deducted from investment returns, charged against the assets of the plan, or the employer may elect to pay them.
If the plan involves profit sharing, there might be additional services offered, such as investment advice, computer access to plan information, educational seminars, and many other options. Fees for such extra services can be allocated among individuals on a pro rata basis or charged as a flat fee against individual accounts.
Individual Service Fees that cover optional features offered to individuals. They may be charged separately, such as when a participant has a loan from the plan.
Investment fees, which usually make up the lion’s share of plan expenses. They are assessed as a percentage of assets invested. Investment fees are deducted directly from investment returns, so participants see the net total return after the charges are deducted. The fees may not be specifically identified on statements, and therefore, they may not be easy for fiduciaries to determine.
Because they are indirect, the Labor Department warns fiduciaries to keep a close eye on investment fees. They include:Sales, “load” or commission charges – These are the transaction costs for buying and selling investments. The way sales charges are calculated generally depends on the nature of the investment.
Management, investment advisory, or account maintenance fees – These are charges to pay for managing assets and are usually calculated based on a percentage of the assets invested in the fund. They vary widely depending on the investment product and the manager and might also cover administrative expenses. The Labor Department reminds employers that higher fees do not necessarily signify better performance.
– Source: The U.S. Department of Labor