QDRO restricts loans to AP

[BTG]

I'm reviewing a QDRO for a 403(b) Plan. The Plan permits loans. The QDRO states that the alternate payee cannot obtain a loan. Is it permissible for a QDRO to prevent the alternate payee from obtaining a loan from his share of the account?

[QDROphile]

I am so amazed at your question that I can only respond to a question that you did not ask. ERISA requires loans to be made available only to parties in interest. An alternate payee is usually not a party in interest.

[BTG]

I am so amazed at your question that I can only respond to a question that you did not ask. ERISA requires loans to be made available only to parties in interest. An alternate payee is usually not a party in interest.

QDROphile, DOL Advisory Opinion 89-30A permits loans to be restricted to parties in interest, but surely you would agree that it does not require them to be restricted in this manner. Here, I am dealing with a plan that does not restrict loans to parties in interest. Under the terms of the plan, an alternate payee would be able to obtain a loan. The question is whether that right may be taken away by a QDRO.

[QDROphile]

Where does an alternate payee first get any rights that might be said to be taken away?

[BTG]

Presumably from the plan document and the QDRO...

Am I correct, then, in summarizing your position as follows?

Without the QDRO, the alternate payee does not have any rights. Therefore, the alternate payee only has whatever rights are granted by the QDRO. If the QDRO states that the alternate payee cannot take a loan from his/her portion of the account, no right is being taken away from the alternate payee, because the alternate payee couldn't have taken a loan prior to entry of the QDRO.

I can certainly see the merit to that argument.

However, consider the situation from this perspective: If the QDRO is approved, there will be many alternate payees with accounts held under the plan. All of them can take loans from their accounts, except for this one, whose QDRO says that he/she can't. Couldn't one argue that adherring to this QDRO provision would conflict with the plan's terms? I remember seeing some recent litigation (perhaps the Kennedy decision?) where the court found that the plan document controls over extraneous agreements between parties to a divorce. (Granted, the divorce decree in Kennedy was not a QDRO.)

In addition, consider the following excerpt from DOL Advisory Opinion 89-30A:

We should also note that to the extent that loans are made available to plan participants and benefitciaries regardless of their status as parties in interest, it is the view of the Department that the requirements of section 408(b)(1) and § 2550.408b-1 [i.e., the "reasonably equivalent basis" standard] would have to be satisfied with respect to all the participants and beneficiaries of the plan who are permitted to secure loans with their accrued nonforfeitable benefit under a loan program.

Wouldn't approving this QDRO also violate the "reasonably equivalent basis" standard by denying loans to one alternate payee?

I appreciate the responses... I can see both sides to this one.

[QDROphile]

It would be interesting if the plan document enumerated rights of an alternate payee, but I think such an attempt would be ill-advised. (I think extending loan rights is ill-advised in and of itself.) The plan would be interfering with the divorce court's authority and ability to assign property, including a dispostion that includes balancing various assets. Perhaps a loan right does not seem so offensive, but where do you stop? How about a plan that says that an alternate payee is entitled to half of the participant's benefit? Remember that this all starts with section 401(a) (13) that says no right or benefit can be assigned except though a domestic relations order that is qualified. Section 414(p) says what a domestic relations order must do (mostly formalities and clarity) and what the order may not do (require the plan to do anything the plan does not otherwise do) to be qualified.

My perspective stems in part from the premise that a plan would want to do anything for an alternate payee because of the needless administrative burden. Loans are terrible enough if you can get them paid through payroll deduction. For defined contribution plans other than ESOPs, the various interests are best reconciled by allowing alternate payees to receive payment immediately. Any extraordinary benefits from staying in the plan are generally not desired by alternate payees -- most take distributions ASAP -- and they are privileges that the alternate payee did not have before the divorce, as you observed. I am not arguing against tax deferral or investment elements of staying in the plan.

You get credit for asking if the emperor has any clothes, but I think you are looking through the wrong end of the telescope, aided by a questionable plan design. If my take on QDROs is too superficial, I propose that it is an appropriate reaction to a bad plan feature and an antidote to an inappropriate extension of implications of a bad plan feature.

[GMK]

Where does an alternate payee first get any rights that might be said to be taken away?

Very helpful. Thanks for making me think, QDROphile. (Something I should do more often, of course.)

[BTG]

From a practical standpoint, I completely agree with you: Loans are an administrative hassle, administering them for non-active participants is even worse, and most alternate payees just want to take their money and run. Unfortunately, I can't advise my client to accept a QDRO with potentially problematic provisions under the assumption that the alternate payee will take an immediate distribution and they won't come into play.

The first paragraph of your response prompts an interesting question though: Would it really be necessary for a plan to expressly state that an alternate payee is entitled to a loan for that to be the case? It is my understanding that an alternate payee is treated as a beneficiary for these purposes. See, e.g., Page 14.29 of Sal Tripodi's ERISA Outline Book (2009 version). Based on this understanding, if a plan were to provide for loans to "all participants and beneficiaries," without further limitation, that plan would inherently provide for loans to alternate payees. On the other hand, if my premise is flawed, then perhaps this whole issue is moot.

[QDROphile]

If you think the beneficiary issue trumps the 401(a)(13) restrictions, then you might determine that the domestic relations order was not qualified because the order requires the plan to not provide an option that the plan is designed to provide. That does not really square with section 414(p)(3)(A), but who is going to press the plan? It is no skin off the participant as long as the the participant's remaining account is not involved, such as for security for the alternate payee's loan. You had better work out the loan details in advance because an alternate payee is not like other beneficiaires. The alternate payee's benefit is derivative of the participant's benefit and the participant is still around with full rights for part of the original benefit. That may be a problem or not. I do not think alternate payee benefits are separate from participant benefits, but you might be able to distinguish enough for purposes of the loan rules.

What would you do if if a participant had a loan and the alternate payee was awarded part of the loan as part of the alternate payee's award? Think about the implications and how that might inform what you decide about alternate payee loans generally. I am not going to comment further on the point becuase it requires too much thinking. GMK might like the exercise.

[GMK]