Hardship Distribution vs. Known Divorce

[Guest Taxaholic]

I have a client who wants to take a hardship distribution to fulfill a financial need, a divorce settlement. The plan doesn't inhibit distributions to just the four safe harbor circumstances and leaves it open to the two part test of immediate and heavy financial need, and a the distribution is necessary to satisfy the financial need.

The problem is with an impending divorce, can he take that distribution? I would think the account is frozen for an action like that until a QDRO is produced. Also would it matter if he was taking less than 50%, assuming the court is going to divide it 50-50?

The plan doc restates the statute and gives the administrator the ability to determine if the need meets the above tests.

Any help would be appreciated!

[J Simmons]

Get the divorce court to restructure the divorce settlement and issue a QDRO to give the ex-spouse some of the benefits, with the employee being relieved of the payment obligation that is creating the 'hardship'. Then the plan doesn't have to deal with hardship issue, and the 10% early distribution penalty (if otherwise applicable) would not apply to amount paid directly from the plan to the ex-spouse per the QDRO.

[Guest mjb]

Why should the plan care about a pending divorce if no notice of a dro has been provided to it? Plan is not a party to the divorce and cannot be held liable for paying benefits in according with its terms. The failure to pay benefits to the participant under the terms of the plan could be a violation of the participant's rights or qualification issue. Just because a participant is going through a divorce does not mean that any benefits will be paid to the ex spouse who may receive other property interests. A participant who takes the benefits as a distribution can be required to pay the funds over to the ex spouse under the divorce since they are still subject to the court's jurisdiction, the only difference being that the funds are now after tax. Recommending that the participant get a court order to permit the distribution of the benefits will be considered an intrusion on the employee's rights/privacy- I wouldnt go there.

[jpod]

Assuming both parties are knowledgeable about the QDRO rules and the tax issues associated with qualified plans (perhaps an unworthy assumption, but who knows?), there could be many reasons why the non-employee spouse and his or her lawyer do not wish to receive any qualified plan money as part of the settlement. One that comes to mind is that the non-employee spouse wants all of his or her money now, rather than have to wait until some time in the future if he or she is not able to receive a current distribution pursuant to a QDRO.

[PLAN MAN]

What do the plan's written QDRO procudures say about a pending DRO and the plan placing a hold on the participant's account? Some procedures only permit the plan to place a hold after the DRO is received, others may permit the hold once the plan administrator is notified of the pending divorce. Always go with what the plan documents say.

The plan administrator does not want to be in a position where they can be sued by the alternate payee for allowing the participant to remove assets from the plan.

[Guest Taxaholic]

I can't get the divorce court to restructure, we are the TPA and do not represent either side in this divorce, but I like the idea. The particpant is not in a community property state, but the state will divide the 401k equitably. I don't know the other party but the participant is rather smart and wealthy, and I don't think he really cares about his 401k, it sounds as if he wants to use it to just pay out settlment without having to sell other assets. Although he does state it is his last resort for finances, which just doesn't meet the smell test.

As for the plan doc:

Hardship: I see nothing in the document that says he can't. It comes down to the administrator deciding if he meets the tests, but he also an administrator, which I advised having another partner sign off on the distribution.

QDRO: There is nothing stated in the plan about a "pending divorce" and the admin's knowledge of. There is a freeze clause if there is a dispute about the validity of the QDRO but nothing else.

I think I am leaning towards MJB, I doubt anything is being hidden and he even stated that she would probably sign off on a distribution. It legally isn't necessary but I would hate to advise him of that and then she won't sign and he can still require the distribution starting a legal battle.

[Mike Preston]

I think there is a middle ground here, simply because the individual involved is an administrator. He certainly doesn't want to create trouble for the plan because of his actions, right? If he voluntarily agrees to notify his ex-spouse and the attorney of the ex-spouse that he intends to take a hardship and that if there are any objections he would like to hear about them in advance and he lets the plan see a copy of that communication, then the plan is completely insulated.

Why wouldn't he want to do this if the course of action is legit under the terms of the plan and is not potentially infringing on his ex-spouse's entitlement?

I recognize it is voluntary. I recognize it might cause a few minutes of billable time on the part of the ex-spouse's attorney. But doesn't that have to be weighed against the potential legal squabble should the ex-spouse's attorney take umbrage after the hardship is a done deal?