July 20, 2011 – Family law attorneys are familiar with the use of qualified domestic relations orders (QDROs) for dividing marital property after a divorce. However, many are not aware of how useful QDROs can be for obtaining delinquent or current (that is, prospective monthly) child support and maintenance payments. This article highlights the convenience and other benefits of this strategy.
QDROs are usually used to segregate and distribute money from a qualified retirement plan (for example, 401(k), profit-sharing, and pension plans) for the benefit of an “alternate payee.” The alternate payee is someone other than the plan participant and is normally the spouse or former spouse of the participant.
However, QDROs can only be used in certain circumstances, that is, when the order “relates to the provision of child support, alimony payments, or marital property rights to a spouse, former spouse, child, or other dependent of a participant,” and “is made pursuant to a State domestic relations law (including a community property law).” I.R.C. section 414(p)(1)(B).
Even though child support and alimony payments are listed first in this statute, the overwhelming majority of QDROs are used to divide marital property (such as retirement plan benefits). Still, the code is very clear that QDROs can also be used to procure child support and maintenance payments, regardless of whether they are current or delinquent.
Under normal circumstances, child support payments are nontaxable to the custodial parent who receives them. For example, if ex-wife A owes $1,000 of delinquent child support payments to ex-husband B, ex-husband B pays no taxes on those amounts when received. Rather, if the QDRO is prepared correctly, amounts taken from ex-wife A’s retirement plan and distributed to ex-husband B would be taxable to ex-wife A.
The plan’s administrator will provide ex-wife A with a Form 1099-R at the end of the year and report the distribution to the IRS.
Under these circumstances, the retirement plan administrator is supposed to withhold 10 percent of the distribution amount for federal tax withholding, unless the plan participant requests that the administrator not do so.
It is important to keep this in mind, because the drafting attorney may need to have the QDRO account for that 10 percent reduction so the custodial parent receives the full amount of child support ordered. That is, the QDRO should be drafted to request 10 percent more than is actually owed (for example, if $900 is owed in delinquent child support, the QDRO should request a distribution of $1,000 so that, after the 10 percent withholding is done, the total distribution is $900).
However, many retirement plan administrators are not even aware of, and therefore do not even adhere to, the 10 percent withholding requirement.
These tax consequences do not apply when the QDRO relates to maintenance payments. Rather, distributions from a retirement plan via QDRO for maintenance payments are taxable to the recipient. Thus, a QDRO should be drafted to disburse only the actual maintenance owed to the recipient.
No “early withdrawal” penalty if distribution made through QDRO
Normally, any distribution from a qualified retirement plan to an individual that is made before the individual attains age 59½ is subject to 10 percent tax penalty as an early withdrawal.
However, this penalty does not apply if the distribution is: (a) properly rolled over into an IRA or another qualified retirement plan; (b) made following employment termination and the individual has attained age 55; (c) made as a loan to the individual; or (d) made pursuant to a QDRO.
Some retirement plans work better than others
Generally, most defined contribution plans such as 401(k), profit-sharing, employee stock ownership plans (ESOP), and 403(b) plans work very well for obtaining past-due child support or maintenance payments.
This is true because, unlike many defined benefit plans (traditional pensions), defined contribution plans allow lump-sum distributions.
However, for procuring current (that is, prospective monthly) child support payments, a defined benefit plan may be the better alternative because child support usually is expressed as a monthly amount, just as benefits normally are paid monthly.
So, if the retirement plan in question is a defined benefit plan that allows preretirement distributions, then it will be an easier fit with a QDRO for future child support payments.
It is possible to use a defined contribution plan for future child support payments, but one may need to determine an actuarial present value for the payments, and then request a distribution of that value. Alternatively, because a retirement plan cannot impose a limit on the number of QDROs that can be submitted, one could file a new QDRO every time the payer gets behind on child support payments.
No QDRO can mandate any distribution unless the retirement plan itself provides for one. Defined contribution plans are more likely to allow for immediate distributions than are defined benefit plans.
That is, many defined benefit plans do not allow a participant (or an alternate payee) to begin receiving distributions of any kind until normal retirement age, as defined under the plan (normally ages 62 to 65).
Frequently, individuals who have fallen into arrears on their child support and maintenance payments do not have any other assets that can be easily liquidated.
However, many of these individuals have retirement plan balances or benefits that may be accessible through a QDRO. Family law attorneys representing clients who are owed these payments should consider requesting QDROs to gain payment of these obligations to their clients.
About the author
Timothy L. Stewart is an attorney in the Madison office of DeWitt Ross & Stevens S.C. His practice focuses on employee benefits/ERISA. He frequently advises family law attorneys on retirement plan issues in divorce, and prepares QDROs for both parties, at the joint request of their respective attorneys.