Adi

I'm not sure I follow. Are you saying QDRO APs are subject to the 10% early distribution penalty? See Code Section 72(t)(2)(C) (10% early distribution tax doesn't apply to QDRO distributions).

As support, here's a snippet from the 2004 ABA Q/A with the IRS: 19. §401(k) – Hardship Distributions A participant wants to know if the purchase of principal residence qualifies as a hardship if she is using the proceeds to 'buy out' the equity on her current home from her ex-spouse? Proposed response: Yes, because the dwelling is her principal residence and she is purchasing an interest in it that she didn’t own before. IRS response: The IRS agrees with the proposed answer. The participant is purchasing a part of her principal residence.

A few practical considerations--if a participant is upset with a QDRO hold, the easiest solution for them is to just get the court to sign the QDRO. A state court also may take issue with a plan allowing a participant to drain their account when it was on notice that benefits may shortly become payable to another. I recall one case in which the court did not appreciate a plan making a beneficiary determination and paying death benefits when it knew a former spouse was trying to get a QDRO, notwithstanding the plan's technical compliance with 206(d).

My understanding is that a QDRO awarding benefits to a deceased individual is acceptable, so long as they are a spouse, former spouse, child or dependent of the participant. But since the individual is deceased, their account would then be paid to the individual/entity provided under plan terms. For example, the plan may provide that if no beneficiary is designated (as would be the case with pre-deceasing spouse), then benefits would be payable to the default beneficiary under plan terms. Perhaps you could reach out to the person conducting the QDRO review to see what in particular they're looking for.

This is the approach I typically take (evaluate, suspend/hold benefits, and give the estate a period of time to submit a QDRO on behalf of the deceased ex-spouse). Even if the plan is within its rights to pay out benefits to the participant or another individual and ignore the divorce decree, I'd be wary of a state court stepping in and taking issue with the plan for not suspending benefits when it had notice of the potential assignment. I've seen this situation come up half a dozen times or so--rare but not nonexistent.

Would it not be payable instead to the estate, standing in the owner's place, as this is correcting a distribution that should have been made to the owner during his/her life?

Thank you all for your thoughts and citations. Unfortunately, I do think the DOL's prior guidance in 90-46A remains grey--while these orders are akin to the community property division in that opinion, they also (arguably) derive from domestic relations law. And while the intent of ERISA may not have been permit QDROs in these matters (indeed, several courts speak of QDROs in terms of requiring a divorce or similar domestic relations matter), the plain language of the statute doesn't appear to exclude them. On requiring a hold harmless, I agree that would be beneficial, but I question whether in practice it could be required given a plan's duty to comply with a valid QDRO. Courts often dismiss attempts by plans to invalidate or not process a QDRO for failure to comply with a plan's extraneous requirements outside of 206. Peter, thank you for your analysis and also the citation to Jago v. Jago. While not a federal case, I do think its analysis is quite helpful. In particular, the court's point that a QDRO must derive from a domestic relations matter and cannot be a distinct legal claim. I do wonder if the court might have taken a different position had the "QDRO" in that case been less egregious--that is, it attempted to divide benefits yet keep the character of the funds as community property (else the parties would donate the $$ back to the plan...somehow...), and so there was no other purpose for order except to be able to withdraw funds. The orders I've seen have not done that (i.e., it would appear the benefits become the AP's separate property under these orders), and so do implicate marital property rights to a greater degree. I also wonder how the court would have handled it had there been a PA law in play that does concern division of property during a marriage, as in some other states. In any event, while I like the court's rationale, it's of course always a lot simpler for the court to interpret and opine on a law's intent than it is for a plan administrator. Side note: It's also interesting that the court initially approved the order. I've wondered if courts are rubber-stamping some of these "QDROs" without analyzing this particular issue.

I've recently come across a new type of order purporting to be a QDRO. Colloquially termed "marital" or "post-nuptial" QDROs, these are court orders that transfer property rights to a current spouse but no divorce or legal separation is anticipated; the sole purposes of the court action is to get the court's sign-off on the order. They're entered pursuant to state domestic relations law (for example, some states that permit them have laws governing post-nuptial agreements, similar to prenup laws). Since these are court-signed orders awarding marital property rights to a spouse pursuant to domestic relations law, they technically satisfy 206(d) and would seem to require approval by a plan. Of course, they appear contrary to the spirit and intent of the law. These orders are gaining traction and several law firms are promoting them as a means to get a distribution when a participant is not otherwise eligible under plan terms. There's negligible case law on them. I reached out to the DOL and was told it's not yet an issue on their radar, nor have they opined on it. All of this is reminiscent of the sham divorce issue about a decade ago, where the court told the administrator to take an order at face value and not dig into the motivations. Have any of you come across this yet? Thoughts?

I question this approach. As between the parties, sure, the Participant could be liable directly to the Alternate Payee for not following through with the withholding election required by the QDRO. But I think it's unlikely Plan terms/a state court order trump the Plan's obligation to comply with federal law (sec. 3405), which requires the Plan to withhold 10% unless the Participant elects otherwise. Your proposed approach would have the Plan's terms take that right away from the Participant, arguably adding an additional requirement for an order to be qualified.

See IRS Notice 89-25 for guidance. Specifically: Q-3: What withholding rules apply to qualified plan distributions to nonspouse alternate payees? A-3: Section 3405 of the Code provides that federal income tax must be withheld from all designated distributions unless the individual elects not to have withholding apply. In general, a designated distribution is any payment or distribution from or under an employee deferred compensation plan but does not include the portion of a distribution which it is reasonable to believe is not includible in gross income. Section 402(a)(9) of the Code provides that, for purposes of section 402(a)(1) and 72, any alternate payee who is the spouse or former spouse of the participant shall be treated as the distributee of any distribution or payment made to the alternate payee under a qualified domestic relations order as defined in section 414(p). The withholding rules therefore are applied as if the spouse or former spouse were the employee. However, there is no similar provision for distributions to nonspouse alternate payees. Therefore, distributions to a nonspouse alternate payee during the lifetime of the participant are not includible in such payee's gross income, but instead are included in the gross income of the plan participant. Consequently, amounts shall be withheld from the distribution as if the plan participant were the payee, unless the plan participant elects not to have the withholding rules apply.

Can the plan override the participant's choice (including lack thereof)? I'd argue no. Per Section 3405, the Plan must withhold 10% unless the participant elects otherwise. See also IRS Notice 89-25 (confirming distributions to child AP are withheld from the distribution: "Consequently, amounts shall be withheld from the distribution as if the plan participant were the payee, unless the plan participant elects not to have the withholding rules apply"). And so if a QDRO awarded the AP 100% of P's account, and P doesn't make an election, then the plan should withhold the 10% from the distribution because a QDRO can't dictate federal tax rules or otherwise award funds not available in the participant's account.

I've found this scenario comes up with some frequency. To prevent this issue in the future, consider QDRO Procedures that provide the distribution will be reduced by applicable income tax withholding elected by the P.

Unfortunately, that's how I read it as well.

I agree that the 503 claim procedures could come into play, though I think it may occur after the QDRO is processed/paid. If the order appears to be a valid QDRO on its face, the participant hasn't presented any reasonable challenge to the order, nor taken any steps to challenge it in court, then I think the fiduciary has a duty to process the order (but should do so in accordance with its QDRO procedures and any notification/right of appeal therein). At that point, I see an argument that the participant could make a claim for benefits, but I'd be wary of such claim holding up payment to the AP where there's no viable challenge, particularly now where COVID has extended claim deadlines. As for interpleader, I agree it should be a rarely used tool, mainly limited to situations where a state court may need to make a factual determination (e.g., a participant challenging fraud, or in the beneficiary context, multiple individuals claiming to be married to a participant, etc.).

I agree with Luke. Interpleader can be a good option to protect the plan when benefits haven't yet been paid and there's some uncertainty. Even letting the parties know about that possibility can result in them going back to the court on their own to get an order either confirming or modifying the QDRO. Alternatively, if there's no reasonable challenge to the order, you could give the participant X days to get an amendment to the order or show legal process that he's taking steps to do so. In any event, QDRO Procedures should address how to handle these sorts of situations (and if not, you may want to consider amending them to do so).