Non-Qualified DC and Divorce

[Guest STLGiant]

Anyone having experience as to how to handle separation/distribution issues involving a non-qualified plan and a qualified domestic relations order? Looking specifically for possible pitfalls.

Situation is a deferred bonus program on a revolving 3-year cliff vesting schedule. First year's bonus to the executive is now vested, however, with "haircut" provisions appearing to be a thing of the past, should the non-qualified account held by a rabbi trust be somehow segregated? Comments of stories or experiences sought.

[Guest 401der]

If I were the non-executive spouse, I would prefer to get my cut from some other marital asset than a nonqualified plan of my spouse.

[GBurns]

401der

Why would you not want to get from ALL assets, Q and NQ?

[Guest 401der]

Depending on the terms of the plan and the stability of the employer, I guess I just don't have as strong a sense of security in the NQ assets as I would in the qualified plan assets or the house and other marital assets that I could get my hands on right away. In other words, I'd let the executive have all the NQ assets and get more of the other.

[Kirk Maldonado]

The QDRO rules do not apply to non-qualified plans.

[GBurns]

STLGiant,

Is it really a QDRO or is it a DRO? Why did you use the word "qualified"?

Quite often I find the term QDRO being applied to any Order that is received in connection with the sharing of assets pursuant to a divorce. There is a difference between the 2 types of orders.

[Locust]

The difficult issue is finding out what executive compensation arrangements are out there and how they should be valued. For example, executives might have stock options, split dollar plans, retiree medical, change of control agrements, and SERPs that they and the company minimally value for some purposes (namely tax and financial reporting purposes), and they will give you that value in responding to a spouse's attorney, but that have much greater value.

For example, a SERP might provide for a benefit of 100% of final pay, offset by other benefits, with cost of living increases after retirement and retiree medical. Obviously, this is a benefit of tremendous value, but because it is hard to value and often extensively reported, the executive will tend to minimize the value.

It is important to get all executive agreements, to review insurance documents, rabbi trusts and asset reports on those assets, and to review SEC disclosures if available. It may be necessary to get depositions from the Compensation committee or others with the information.

Under state law the spouse may not be able to get a piece of all of these, but it is important to get the information so that the spouse (and if it goes to court, the court) will have the full financial picture.

[QDROphile]

Top hat plans are not exempt from Part 5 of ERISA and section 514(b)(7) mentions QDROS and QMCSOs. I don't know what a rigorous analysis would conclude about this, but I am more comfortable when the order meets QDRO requirements and it is usually not much of a burden to achieve that.

[Kirk Maldonado]

ERISA Section 514(b)(7) provides as follows:

Subsection (a) shall not apply to qualified domestic relations orders (within the meaning of section 206(d)(3)(B)(i)), qualified medical child support orders (within the meaning of section 609(a)(2)(A)), and the provisions of law referred to in section 609(a)(2)(B)(ii) to the extent they apply to qualified medical child support orders.

I agree that qualified domestic relations orders are not preempted by ERISA, as evidenced by the above language.

However, the threshold issue is whether nonqualified retirement plans are subject to the QDRO rules. In the case of ERISA, the QDRO rules are contained in section 206. However, nonqualified retirement plans are exempt from the provisions of Part 2 of Title I of ERISA (which includes section 206). Thus, nonqualified retirement plans are not subject to the QDRO rules.

[mbozek]

There are at least 5 cases where fed cts have enforced QDROS involving life ins benefits, e.g. Met Life v. Marsh, 119 F3d 415, which are exempt from non alienation rules, because the QDRO provisions are an exemption from the preemption provisions of ERISA for all plans subject to ERISA, not just pension plans.

[Kirk Maldonado]

I'm not saying that there aren't any cases applying QDROs in those circumstances. There are many ERISA cases that are wrongly decided (in my book).

But to be subject to the QDRO rules or even the non-alienation rules, the plan has to be first subject to Part 2 of Title I of ERISA, and it doesn't apply to nonqualified retirement plans.

Because the nonqualified plan is subject to Part 5 of Title I of ERISA, it enjoys the pre-emption of state laws. Also, because it isn't subject to Part 2, it is not subject to the QDRO rules. While it would be hard to convince a court of that result, I think that is the analytically correct result.

On the other hand, I would never advise a client to fight this point. The odds of losing are great and the legal fees could be astronomical.

[Guest 401der]

STL Giant, the thread reinforces my original suggestion that it might be easier and safer to just get the other marital assets and leave the nonqualified assets alone.

[GBurns]

STLGiant,

See the post by Locust.

In any divorce or property sharing situation, it is only sensible to look at ALL assets. Until ALL assets are looked at, the total value cannot be determined. That is what asset searches are for. Without identifying and quantifying ALL assets, How can a rational decision be made regarding sharing/splitting?

In many cases NQ assets will be more than Q Plan assets. It seems foolish to just look at Qualified plans only.

It seems foolish to worry about what is "easier" without knowing the value. "Safer" is irrelevant. That is what lawyers are for.

[Guest 401der]

I wasn't suggesting that the nonqualified assets not be considered, only that they not be used to fund any part of the spouse's property settlement. Certainly if the total marital assets (including the NQ plan) are $X, and the parties agree to a 50% split, rather than take 50% of the NQ assets, I would prefer to take an additional percentage interest in the home or qualified plan or other investments equal to 50% of the NQ assets. So long as NQ assets are subject to the claims of the employer's creditors, I'd just as soon have something else.

[GBurns]

Why would a distribution of the NQ assets to another party be subject to claims by creditors of the plan participant and/or their plan sponsor/employer?

Once split and disbursed to the other party, there is no claim that could be made that I can think of other than those related to fraudulent transfer, bankruptcy or Medicaid look back, none of which should be applicable anyhow.

I would not think that a spouse who looks at assets and sees House Equity $ 120,000; Checking account $3,000; IRA $20,000; 401(k) $200,000; NQDC/SERP/Stock Options etc $ 400,000 would be rational to take 50% of the Q assets and leave the NQ because it might cost a few $ for a lawyer to get an unencumbered amount.

You fund the settlement with whatever and as much as you can get.

[Belgarath]

I don't think that is what 401der is saying. If I understand 401der correctly the suggestion in this case would be to total the assets (I get 743,000) and assuming the marital property split is 50/50, the alternate payee is entitled to 371,500. I believe 401der is recommending in this case that the alternate payee take 100% of the house, checking, IRA, 401(k), and as little as possible of the NQ - in this case, 31,200 from the NQ. I have no opinion as to whether this is better than a straight 50/50 split of all assets, but I think this is what 401der is advocating.

401der - am I correctly understanding your position?

[Guest 401der]

Dead on, Belgarath. Since it's all a matter of negotiation of the property settlement and the particulars of the NQ plan and other assets available, it may not be possible to avoid getting some of the NQ assets, but I was just saying that if I were the spouse (or the divorce attorney for the spouse), I would try to get something besides the NQ assets.

[GBurns]

Whereas I would just get as much possible from all sources. 100% of whatever I can squeeze. Let the other party squirm and object if they can.

If I can get 100% of the house because of the children's need for shelter, then I still want as much of the rest as possible Q and NQ for support, repairs whatever.

Why limit my thinking to taking 50/50, 75/25 or anything else first? I can easily negotiate down but I have very rarely seen anyone negotiate up very much.

[Harwood]

Does the non-qualified plan document even allow for this type of distribution [which is taxable on the participant's W-2] ?

[GBurns]

Isn't also taxable when from a Q plan?

[Harwood]

QDRO payments to spouse and ex-spouse Alternate Payees are taxable to the Alternate Payee, not the Participant.

[Guest STLGiant]

Thanks for your posts to-date. Here are some facts. Case would be in New Jersey if that matters. Yes there is a 401k plan and I think that will be attached as usual by the spouse. As to the use of DRO vs. QDRO it was a qualified vs. non-qualified slip of the fingers, although I am also aware of the cases where QDROs were involved in NQDC agreements.

Since the plan dictates that there is was only access for a distribution with a 10% penalty (haircut), and since the haircut distributions appear to be frowned upon under the most recent reg changes, I agree that 100% of something now is better than 50% of a future benefit payable.

That being said...

If spouse with NQDA takes distribution and haircut and loss of participation in plan (per plan document), will that NQDC participating spouse bear all the brunt of the taxes, or will a portion be borne by the non-participating spouse subsequently receiving the NQDA benefits in the form of a DRO?

Second, has it been most of your experiences that the better posturing is to barter the PVAB in the NQDA (if that can even be calculated since distribution is typically post-separation of service) and not give up any NQDA benefits?

Third, has anyone seen where a NQDC plan apportioned or set-up a sub-account for the non-particpating spouse in an active NQDC plan?

[Kirk Maldonado]

Harwood:

You said:

QDRO payments to spouse and ex-spouse Alternate Payees are taxable to the Alternate Payee, not the Participant.

While that is true, two thing are worth mentioning. First, that result is mandated by specific language in the Internal Revenue Code, so that a different result may apply in situations not involving a QDRO. Second, this message thread does not involve a QDRO.

As for the tax treatments of amounts distributed from a nonqualified plan to the non-employee spouse, look at Rev. Rul. 2004-60.

[Guest ircreader]

We've got a pretty simple solution - we don't accept a DRO for NQ assets. We tell the parties to work out an agreement between themselves. QDROs don't apply to NQ plans. Some participants prefer to have the Q assets paid to the alternate payee (AP) since the taxability transfers to the AP for their share. All NQ benefits remain fully taxable to the participant.

[mbozek]

Saying that NQDC is not subject to QDROs invites a lawsuit from an AP who has the exsiting precedents on LI benefits being considered subject to a QDRO on her side. State cts have also held retiree health benefits to be an aset of the marital estate. Most participants will not trade qualifed plan benefits in order to keep the NQDC because of the restrictions under 409A and the risk of loss in the event of employer bankruptcy or termination for cause. There is no distinction in taxation of Q benefits and vested NQDC paid to the AP other than NQDC cannot be rolled over to an IRA.

[david rigby]

There is no distinction in taxation of Q benefits and vested NQDC paid to the AP other than NQDC cannot be rolled over to an IRA.

Is there not a potential for different FICA taxation?

[mbozek]

The Employee will be liabile for FICA tax on distributions to the AP to the extent the payments are FICA wages. However, since NQDC is usually taxed when vested, payments to the AP will be subject to FICA tax only if not previously taxed as FICA wages.

[Harwood]

Check out Rev Ruling 2004-60 that Kirk Maldonado recommended: http://www.irs.gov/irb/2004-24_IRB/ar13.html

[Guest dsilver]

Check out Rev Ruling 2004-60 that Kirk Maldonado recommended: http://www.irs.gov/irb/2004-24_IRB/ar13.html

Thank you for that link!

[Steelerfan]

Saying that NQDC is not subject to QDROs invites a lawsuit from an AP who has the exsiting precedents on LI benefits being considered subject to a QDRO on her side. State cts have also held retiree health benefits to be an aset of the marital estate. Most participants will not trade qualifed plan benefits in order to keep the NQDC because of the restrictions under 409A and the risk of loss in the event of employer bankruptcy or termination for cause.

This topic is so interesting I had to respond.

I had a tax court judge as a professor who was mentally impaired enough to think that QDROs could apply to NQDC plans. People who are too afraid not to use a QDRO are setting a bad precedent and analytically, it is clear that non qualified plans are not subject to QDROs. Even just the logic of applying a "qualified" rule to a "nonqualified" plan ought to give some hints as to the right answer. That being said, litigation of wrong positions can't always be avoided.

BTW ERISA does not and has never interfered with a state's right to decide what is marital property (except with respect to the joint and survivor annuity). The only limit ERISA places on divorce courts is that with plans subject to QDRO rules, you must procedurally use a QDRO to get at the assets themselves. I thought Gburns misunderstanding of the division of marital property was entertaining.

[jpod]

In fact, a non-qualified plan CAN be the subject of a QDRO. The QDRO rules apply to any pension plan subject to part 2 of Title I of ERISA. While you don't see them too often, a non-qualified plan may be subject to part 2 of Title I. For example, a plan that was thought to be a top-hat plan but in fact is not a top-hat plan (e.g., because the participant group is too large) is a plan subject to part 2 of Title I (as well as parts 1, 3 and 4, but that's another story).

[Steelerfan]

In fact, a non-qualified plan CAN be the subject of a QDRO. The QDRO rules apply to any pension plan subject to part 2 of Title I of ERISA. While you don't see them too often, a non-qualified plan may be subject to part 2 of Title I. For example, a plan that was thought to be a top-hat plan but in fact is not a top-hat plan (e.g., because the participant group is too large) is a plan subject to part 2 of Title I (as well as parts 1, 3 and 4, but that's another story).

This is a can of worms I am afraid to even talk about!

[Guest mjb]

See Bass v. Mid America, 1995 US Dist Lexis 15719, where a fed court construed a divorce decree ordering payment of 50% of an employee's monthly $2,000 non qualified pension to the ex spouse to be a QDRO subject to ERISA, not state law.

[katieinny]

We tried submitting a QDRO to an employer for a non-qualified plan. They told us that non-qualified plans are not subject to QDROs and refused to accept it. We were told that there is no access to those funds by the ex-spouse.

[Steelerfan]

We tried submitting a QDRO to an employer for a non-qualified plan. They told us that non-qualified plans are not subject to QDROs and refused to accept it. We were told that there is no access to those funds by the ex-spouse.

They'll tell you anything to get rid of you. Was the QDRO signed by a judge? You need a family law lawyer well versed in employee benefits matters. The determination of whether assets are marital property is for a state court to decide, and the plan or employer, as applicable, can be forced to comply with a court order (you generally don't need a QDRO, just a DRO should do). A contempt order might get their attention.

[Guest mjb]

SF: How does a court hold the plan admin in contempt when the plan admin is not a party to the action? Regardless of the case law, the plan has the right under ERISA to refuse to qualify a DRO from a NQDC. Many companies will approve a division of NQ plan benefits under an order similar to a QDRO as long as the DRO does not provide that the transfer of the NQ plan benefits is subject to IRC 414(p). If the plan admin refuses to divide the benefits under a non 414(p) dro the remedy for the AP is to commence an action under ERISA to enforce the DRO.

[katieinny]

mjb -- Just to be clear, your suggestion is to replace the QDRO with a DRO, submit that to the employer with a cover letter saying that if it is not accepted we will bring an action under ERISA.

[Guest mjb]

my suggestion was to ask if the plan admin to accept a DRO that had all of the substantive provisions for dividing the NQ benefit except that it would not be deemed to be a QDRO under 414p which would then eliminate the objection that NQ benefits are not subject to QDROs. Before threatening a lawsuit you need to discuss the practical aspects of such action with the client such as the cost to the client, the time it may take to get a decision, the prospect of an appeal, likehood of success, etc. to see if the client wants to pursue this option if the Plan admin will not accept the DRO.

[Steelerfan]

It makes no difference if the DRO is qualified or not, they are just giving her the runaround. ERISA does not have an enforcement procedure for non participants. If they won't comply with a QDRO, why would they comply with a DRO (it's just semantics)? My guess is they will say that the plan benefits or assets (if any) cannot be alienated by the P.

The point I'm trying to make is that generally state law is the final say as to what is marital property as well as how and whether or not you can get to any assets in a NQDC plan rabbi trust. Additionally, there may be no "assets" or "plan administrator" in the ERISA sense but only a promise (no rabbi trust, etc.) by the employer. (ERISA 206(d) may not matter much if there are no plan assets to alienate, but only future payments). [although some, like mjb, take the position that ERISA's QDRO rules apply to top-hat plans and, therefore, that top-hat plans must honor otherwise qualifying QDROs, regardless of whether or not the plan contains QDRO provisions.]

If there is a rabbi trust, the issue is whether the spendthrift provision in the trust can prevent the assigment to the ex-spouse. At this time practitioners presume (and hope) that state law spendthrift trust rules would cause courts to respect a rabbi trust's nonalienation provisions, but there is no clear answer. The real issue here is how to enforce a state court divorce order against the ER for assetsor future payments that a state court presumably validly concluded were marital assets, despite the presence of anti-alienation provisions in one form or another.

BTW Under 409A, a nonqualified plan is permitted, but not required, to include a provision allowing payments to a former spouse pursuant to the terms of a domestic relations court order. The Final Regs provide:

(ii) Domestic relations order. A plan may provide for acceleration of the

time or schedule of a payment under the plan to an individual other than the

service provider, or a payment under such plan may be made to an individual

other than the service provider, to the extent necessary to fulfill a domestic

relations order (as defined in section 414(p)(1)(B)).

[Just Me]

Funds paid from NQDC account within the preference period preceding a bankruptcy of the employer are subject to a claim by creditors and may be required by law or court order to be paid back to the estate. See Enron case for example.

[Steelerfan]

Funds paid from NQDC account within the preference period preceding a bankruptcy of the employer are subject to a claim by creditors and may be required by law or court order to be paid back to the estate. See Enron case for example.

that's pretty much a classic example, although a prolific case, of the reason for making the plan "unfunded" --it's what you give up to get the tax deferral. The creditor's have the first crack at rabbi trust money, before participants and portential alternate payees. That's the reason for the anti-assigmet clause in the first place--to protect the creditors agains the employee from assigning the money (essentially assigment would cause early taxation)