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SHAM QDRO


Guest SCUDDESLER

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Guest SCUDDESLER

Our client sponsors a qualified plan. A participant in the plan is going through a divorce. The divorce court, through the divorce decree, has ordered the plan to pay the ex-spouse 100% of the participant's vested account balance. The divorce decree goes on to provide that the ex-spouse must then pay 50% of the distribution to the participant. The participant is not yet 59-1/2 and is still actively employed. First, does the plan have to worry that the DOL or IRS will raise any objections to the QDRO? Second, is this a tool by which the participant can get at some of his (in this case) retirement plan assets while avoiding the early distribution penalty tax? The divorce decree also provides that the participant, once he receives 50% of the distribution initially made to the ex-spouse, will then be responsible for reimbursing the ex-spouse for his "share" of the income taxes applicable to the distribution.

Thanks so much for your help and comments.

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Do you ever wonder about the atty's and judges who see/write these? I admit they know nothing of ERISA most of the time, but why don't they ever ask. (am done whining).

If it were me I would be on the phone to ERISA councel big guns. You say divorce decree states alt-payee give half back to participant. In 90% of the QDRO's I handle I don't see decree or property settlement. I just get the QDRO.

If you had not seen decree, only the finished QDRO, would you ask the questions? Seems to be a lot of this going around here on BenefitsLink. Makes me wonder how many of them are really sham.

(Maybe I should start requiring copies of decree and property settlement with every DRO).

JanetM CPA, MBA

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I think a plan needs to be very careful about minding its own business and considering only those things that are necessary and proper for law and plan compliance. Domestic relations orders can cover a lot of ground and much of it can have nothing to do with the plan or QDRO requirements. Once a plan administrator ventures outside the plan concerns, the ground gets very slippery.

The plan administrator is not the federal marshall. This situation is different from the Advisory Opinion on the bona fides of the divorce. That does not mean that the plan turns a blind eye to what is put in front of it, either. On balance, I think the plan is not responsible for what the alternate payee agrees to do with property or what the court orders the alternate payee to do with property, but this situation begs for the plan to get its own competent legal advice.

You might consider that the consequences of the participant paying a "share" of the taxes will multiply the applicable taxes (the payment of the share is income to the AP), probably beyond the 10% amount, so the deal has real economic and tax effects. Will they comply with tax law in this respect? Is it the plan's issue?

Asking for ancillary documents is generally a bad idea. Additional documents compound problems, especially with interpretation.

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I agree with QDROphile. However, the issue is what to do once a plan has been informed of something that it didn't go looking to find, such as the ancillary arrangements found in this case. Again, QDROphile has it right. Hie thee to an ERISA attorney.

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Otherwise where do you draw the line? What if they intend to split all assets 50%. But employee has physical custody of children and wants to keep the house. So for convenience they give spouse 100% of a $250,000 plan balance and custodial employee gets the $250,000 house. In essence employee has received 50% of each asset (including the plan) and then bought the spouse out of half of the house.

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Guest SCUDDESLER

Thanks to all for your comments/suggestions. It seems to me that so long as the QDRO complies with the applicable law and the plan does not have knowledge that the divorce itself is a "sham", then the intended use of the distributed plan assets as well as the legality of any "side agreements" is not the plan's concerns (it's the concern of the parties and the court). One of the respondents put it well, I think, with his/her comment that the plan is not a Retirement Plan Marshall obliged to root out questionable court orders. Does anyone disagree with this position and, if so, why? Thanks again.

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I agree that the administrator should keep the blinders on and only worry about whether the order meets the QDRO requirements.

When the ex-wife transfers the money to the husband, won't there be a second tax attached to the transfer? It seems as if they will pay once on the distribution and

a second time for the transfer.

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Guest b2kates

Mal, the transfer from the plan to the ex spouse would result in the ex spouse owing income tax.

Under divorce tax law however the transfer from exspouse to participant, incicdent to the divorce is not subject to tax on the second exchange.

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Guest Kevin Wiggins

It seems to me they are doing this to avoid the 10% penalty on the participant and, depending on the plan, to get an in-service distribution where one would not otherwise be available.

Absent evidence of a sham divorce, I don't see this as a QDRO problem. If the plan sponsor doesn't want APs do to this, the plan could be amended to prevent an AP from getting any distribution until the participant's earliest retirement age.

I hate to raise the issue because I know I'll get a lot of flack for it, but why not have some fun? I'm not saying it is, but does anyone think there could be an impermissible in-service distribution problem that disqualifies the plan if one is not otherwise permitted under the Plan?

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I don't think the plan has any choice but to comply with the DRO if it satisfies the QDRO requirements. I think this is a perfectly valid loophole; the IRS may not like it, but I can't see what legal authority it would have for attacking it.

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Guest erisa.com

All concerned might find it worthwhile to look at DOL Advisory Opinion

1999-13A

09/29/99

ERISA Sec. 206(d)(3)

Brian G. Belisle

Oppenheimer Wolff & Donnelly, LLP

Regarding how a plan administrator should treat domestic relations orders the plan administrator has reason to believe are “sham” or “questionable” in nature.

UAL Corporation and United Air Lines, Inc.

I think it settles the question.

Link is http://www.dol.gov/ebsa/regs/AOs/main.html

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kirk: I am assuming that the divorce was not a sham; there was no suggestion by the original poster that it was a sham. The inference I drew from the poster was that the participant was using his divorce as the vehicle for tapping his retirement plan. Therefore, I can't imagine that the IRS would be so bold as to try to disqualify the plan for complying with the order or if it did try that it would be successful in court. I suppose the IRS could go after the participant and try to assess the 10% addition to tax, but only because he would be easier prey. I'm a little rusty on the step-trans. doctrine, so let me ask you the question: how do you think the step-transaction doctrine would apply where there is an order issued by a state court judge which all parties are compelled to honor?

erisa.com: Again, I am assuming that the divorce was not a sham, and I agree that the facts involving the UAL situation present an entirely different kettle of fish. But, even the UAL opinion says that the plan administrator does not have undertake a great deal of due diligence if he smells a rat.

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jfp:

The point I was trying to convey in my prior message was that I think that the IRS has grounds to attack the participant for the non-payment of the Section 72(t) tax.

I will admit that I did not expressly limit the comments in my prior message to the participant. That was because I thought it was unnecesary to state that point because there is no basis on which the IRS could assert that the step transaction doctrine applies to anybody else involved in the transaction.

Kirk Maldonado

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Kirk: Fair enough.

The reality, however, is that there will be a 1099-R issued to the alternate payee, and no 1099-R issued to the employee, so the IRS will never find out about this, unless the employee's return for the year in question happens to be selected for audit, and even then I would doubt that your average 1040 examiner would pick this up in a million years.

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The other fact is that someone has to bear the expense of a divorce (sham or not) and the QDRO, in order to avoid the 10% excise tax.

I'm a retirement actuary. Nothing about my comments is intended or should be construed as investment, tax, legal or accounting advice. Occasionally, but not all the time, it might be reasonable to interpret my comments as actuarial or consulting advice.

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jfp:

You are certainly right that the odds of getting caught on this issue are extremely remote, to say the very least.

My comment was more aimed at what is the likelihood that this arrangement would pass any degree of scrutiny if any competent person at the IRS discovered it.

Your comment was more practical, mine was more theoretical.

In that regard, I think that the client needs to be appraised of both; that the risk of getting caught is very slim, but if it does come to the attention of the IRS, then the client will almost certainly have a full-fledged fight with the IRS about it. If that happens, the client will spend a lot of money fighting the IRS and may ultimately lose. It all boils down to the risk tolerance level of the client.

Kirk Maldonado

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I'll admit that it sounds like some advanced tax planning is being done in this case but I would like to respond to the above comments about keeping blinders on in reviewing DROs. While I agree it's not the Plan's job to second guess the motives of the parties, I do think all parties often benefit where the plan admiinistrator questions or confirms the intent of certain DRO division and distribution provisions. I routinely see poorly drafted orders that arguably meet the QDRO requirements but do not really make sense. When counsel is questioned about these provisions, we frequently find that the provisions are not as intended and the order gets revised. I would just caution plans not to put on complete blinders in reviewing DROs.

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