Wisconsin Lawyer
Vol. 79, No. 10, October
2006
When Lovebirds Split:
Dividing the Retirement Nest Egg at Divorce – Properly Dividing
Pension Benefits
The impact of an improper pension division can be devastating for
clients, because they may lose out on the pension benefits altogether,
and for family law practitioners, because they may face a minefield of
malpractice claims and disciplinary actions. Learn how federal and state
laws intersect with pension plans so you can protect your clients'
economic future and avoid malpractice issues.
by Nilesh Patel
ension benefit issues have been at the forefront of problems facing
employees, companies, and U.S. lawmakers. Notable examples are in the
airline and automobile industries, with companies such as United
Airlines, Delta Airlines, Northwest Airlines, and Delphi dumping their
pension plans in bankruptcy proceedings or terminating their pension
plans.
There is, however, another category of pension problems that is not
as prominent in the public eye. These problems, improperly dividing
pension benefits at divorce, are harder to track because they occur
individually and may go unreported by clients. The impact of an improper
pension division can be more devastating than that of a pension
termination, because in a termination, pension insurance can provide
most if not all of the expected benefit amount. With an improper pension
division the client may lose out on the pension benefits altogether. For
example, in Lee v. Lee, an unpublished Wisconsin Court of
Appeals decision, a husband was not able to reopen a divorce decree
after realizing that he misunderstood the full scope of the pension
division.1 Loss of pension benefits is
especially severe for older divorced persons, because pension income
often is one of the few financial assets outside of Social Security
available to stave off poverty.
Pension division issues need to be carefully addressed by family law
practitioners. Failure to divide a pension properly during a divorce can
lead to a minefield of malpractice claims and disciplinary
actions.2 Judges also need to be aware of
the formal rules for pension division if their property division orders
are to be properly enforced and have the desired effect. In addition,
judges need to be aware of pension division issues because of the
increasing number of pro se divorces, a number that may be as high as 70
percent of all Wisconsin divorces,3 in which
the litigants will look to the judge to guide them to an equitable
property division.
Scope of the Article
Nilesh P. Patel, U.W. 2002, is a
former staff member of the Upper Midwest Pension Rights Project (UMPRP),
a federally funded nonprofit that provides free pension claims
assistance to residents of Wisconsin and four other states. Currently,
he is an advisor in the U.W. Law School's Career Services Office and
principal attorney in the Mahadev Law Group LLC, Waunakee, which focuses
on employment law issues. The author thanks UMPRP attorney Christopher
Rendall and law clerks Robert Ellis, Matthew Johnson, and William
Roberts for their assistance. Thanks also to attorney John Hotz, deputy
director of the Pension Rights Center in Washington, D.C.
This article describes: how the federal Employee Retirement Income
Security Act of 1974 (ERISA) affects the division of pension benefits at
divorce, historically an issue governed only by state law; qualified
domestic relations orders (QDROs) - the only legal tool for enforcing a
pension benefit division; and issues that attorneys need to consider
when drafting or submitting QDROs and that judges need to consider when
dealing with pro se divorcees.4 The article
covers the major legal issues to provide an overview for the occasional
family law practitioner and a refresher for the experienced one. This
article does not cover specific strategies or drafting techniques for
QDROs5 or remedies for improper pension
divisions.
Definition and Types of Pension Benefits
In this article, the term "pension benefit" refers to any plan
sponsored by a private employer or by a labor union that provides: 1)
retirement income; or 2) deferred income payable at retirement or after
employment has ended.6 All of the pension
benefits discussed here are subject to ERISA. There are other pension
and retirement benefits, however, that are not covered by ERISA7 and that may have their own pension division
rules, such as those set up by federal, state, or local government
employers; tax-exempt church plans; plans maintained solely to comply
with worker's compensation, unemployment compensation, or disability
insurance laws; plans maintained outside the U.S. primarily for
nonresident aliens; and excess benefits plans.
There are three types of ERISA-regulated pension benefits. One type
is the traditional employer sponsored pension plan, known also as a
defined benefit plan, in which an employer promises a predefined monthly
benefit amount to the employee. The predefined amount typically is based
on a formula, such as the employee's average annual salary over the
three highest earning years, times a multiplier (usually between 1 and 2
percent), and multiplied again by the employee's years of service. In
defined benefit plans, it is the employer's responsibility to fund the
pension plan and to come up with the money to pay the promised benefit
amount.
A second type is the defined contribution plan, in which the
employee's benefit is based on contributions by the employer, the
employee, or both, to an individual employee account. The benefit, or
account balance, is typically paid out in a lump sum. The employee often
bears the responsibility of funding the plan and the risk for managing
the funds, so that the employee will be provided with a sufficient
retirement income. Examples of such plans include 401(k) plans, money
purchase pension plans, profit sharing plans, stock bonus plans, and
employee stock ownership plans.
The third type combines features of the first two plans and commonly
is referred to as a "hybrid plan." These plans are relatively new and
quite controversial because older workers allege the benefits accrual
formula discriminates against them.8
Examples of such plans include cash balance plans, pension equity plans,
floor-offset plans, age-weighted profit-sharing plans, and target
benefit plans.9
State Law Divides Pensions but the Division Must Comply with ERISA
to be Enforced
During a divorce, pension benefits often are one of the largest
divisible assets and probably the largest if the couple does not own a
house. The division of property at divorce is governed by Wisconsin's
domestic relations law. Currently, Wis. Stat. section 767.255(2)-(3)
states that a court shall presume that all property, except property
acquired as a gift from someone other than the spouse or by reason of
the death of another person, is to be divided equally between the
parties.10 As far back as 1958, Wisconsin
courts have considered pension benefits as part of the marital estate
and either divided them or distributed other assets to mimic a pension
division.11
In Steinke v. Steinke, the Wisconsin Supreme Court ruled
that a spouse's interest in a pension plan is part of the marital estate
that must be divided at divorce, even if the pension plan funds are
unavailable at the time of divorce.12 The
court concluded that a pension plan is part of the wealth that
accumulates during a marriage and, based on the policy that a marriage
is a partnership in which each spouse contributes something valuable,
each spouse must equitably share in the accumulated wealth and assets at
divorce.
The Wisconsin Court of Appeals reinforced this policy in Rodak v.
Rodak, in which a husband sought to have the premarital portion of
his pension contributions excluded as nonmarital property during
divorce.13 The court of appeals ruled that
the amount of pension benefits earned before marriage may be considered
as a factor in how the marital property is divided at divorce
under Wis. Stat. section 767.255(2),14 but
the pension's full value nevertheless must be included in the couple's
marital estate.
Although a Wisconsin court has the authority to divide a pension at
divorce, attorneys and judges should be aware that they must take
federal law into account to enforce the division. A judge may issue a
simple order stating that each party is to have a 50 percent interest in
available pension and retirement plans, but the pension plan may not be
bound to honor that order due to ERISA.
Congress Sets a Federal Standard for Pension Benefits
The U.S. Congress passed ERISA in 1974 to regulate the administration
of private pension plans and to provide, through the Pension Benefit
Guaranty Corporation (PBGC), some protection to individuals whose
employers are unable to meet their pension obligations.15 ERISA bolstered protections for pension
participants and beneficiaries. Employers offer pension benefits in
order to take a tax deduction on contributions and to provide a
competitive benefit to recruit workers. Before ERISA's enactment,
however, there were no standards regarding minimum eligibility periods,
vesting periods (length of service before benefits are, for the most
part, unforfeitable), and break-in-service penalties, nor any standards
regarding what would happen if the employer underfunded the plan and
could not pay out the promised benefit. Many plans had 15- or 20-year
vesting periods, during which the employee continuously had to work for
the company, without a break in service. If employment was terminated
before the vesting period was completed, the entire pension benefit was
lost. So while the employer gained the benefit of the tax deduction, the
employee and family were left with nothing at retirement, even when the
employer terminated employment in order to avoid paying pension
benefits.16
ERISA imposed minimum standards on pension plan administrators for
information disclosure, vesting, eligibility, and fiduciary duties,
thereby requiring employers and administrators to act only in the
interest of the plan participants and beneficiaries. ERISA also provided
an enforcement mechanism by which participants could sue for fiduciary
violations, for wrongful denial of benefits, and for a variety of
technical and statutory violations, including discrimination,
retaliation, and interference with ERISA rights.17
Congress intended ERISA to be the only standard for pension plans and
added a preemption clause stating that ERISA supersedes any and all
"state laws" that "relate to" an ERISA-covered pension plan.18 This preemption clause prevents conflicting and
inconsistent regulation of pension plans by state and local authorities.
The term "state laws" refers to state statutes as well as all laws,
decisions, rules, regulations, or other state action having the force of
law that directly or indirectly regulate the terms and conditions of an
ERISA-covered pension benefit plan.19 State
common law and the rules of any political subdivision, agency, or
instrumentality also are preempted. Because of ERISA's preemption
clause, participants, beneficiaries, and plans are limited to the
rights, obligations, and remedies provided by ERISA and a supplementary
body of federal common law.20
Another of Congress's goals when passing ERISA was to ensure that
participant benefits were available at retirement. One of the ways ERISA
achieved that goal was through an anti-alienation/anti-assignment
clause, which prevents a participant from assigning benefits to anyone
else and prevents a third party from garnishing or levying the benefits
to pay a debt.21 ERISA, however, exempts
from the anti-alienation clause collection and enforcement of unpaid
federal, state, or local taxes and collection of overpayments by the
plan.22
Judicial Exceptions to ERISA Preemption
Naturally, the preemption and anti-alienation clauses created a
problem for plan administrators in situations in which state courts
ordered the division of pension benefits. After ERISA's enactment, plan
administrators were placed in the uncomfortable position of either
obeying a state court's order to divide a pension or following ERISA's
mandate to act in the participant's interests and rejecting any
alienation or assignment of plan benefits. Such a situation occurred in
Wisconsin in 1979, five years after ERISA's effective date.
In Savings & Profit Sharing Fund of Sears Employees v.
Gago,23 a Wisconsin family court
commissioner awarded one-half the value of a husband's pension fund to
the divorcing wife. The husband, however, refused to comply with the
order and when the wife asked the plan for payment, it refused based on
its belief that the division would violate ERISA. The wife then filed an
action in circuit court, which ordered the fund to make direct payments
to the wife. The fund then filed an action in federal court to stop
enforcement of the state court order. The federal district court and
ultimately the Seventh Circuit Court of Appeals ordered the fund to
comply with the Wisconsin court order.24
In deciding this case, the Seventh Circuit considered whether ERISA
preempted the Wisconsin law and whether the pension division was a
prohibited assignment or alienation under ERISA. The court recognized
that the Wisconsin order "related to" a pension plan governed by ERISA
because, in the normal sense of the phrase, it had a connection or
reference to the plan. Nevertheless, the court resolved the preemption
issue by citing to the U.S. Supreme Court opinion in Shaw v. Delta
Air Lines, in which the Court stated that some state actions, such
as pension garnishment to enforce alimony and support orders, are too
tenuous, remote, or peripheral to be considered to "relate to" an ERISA
plan.25 Because the Shaw child
support/alimony order occurred in the context of a divorce, the Seventh
Circuit reasoned that a property division in the context of a divorce
also was too tenuous to require preemption.
The Seventh Circuit also rejected the fund's argument that the
pension division was an impermissible assignment or alienation under
ERISA. If the court had found a conflict between the Wisconsin order and
ERISA, the Wisconsin order would have been preempted based on the
Supremacy Clause of the U.S. Constitution.26 That being said, federal courts tread lightly in
the context of state domestic relations law and will not find a conflict
unless state family law and property law do major damage to "clear and
substantial" federal interests.27 While the
Supreme Court had found a conflict and preempted state laws in cases
like McCarty v. McCarty28 and
Hisquierdo v. Hisquierdo29 because
state courts were dividing federal benefits in a manner
contrary to the federal framework, the Seventh Circuit found no such
damage to federal interests in Gago. Considering that one of
ERISA's goals was to have benefits available for participants and their
dependents or beneficiaries, the court reasoned that there was no
conflict because Congress had not tried to limit pension divisions at
divorce.
Congress Reasserts Federal Supremacy and Increases Protections for
Women
While Wisconsin courts and the Seventh Circuit ruled that ERISA did
not preempt state court divisions of pension benefits at divorce, a
split occurred among other states and federal circuits.30 A year after Gago was decided, Congress
passed an amendment to ERISA, the Retirement Equity Act of 1984 (REA),
to address the split among the circuits and to clarify that with limited
exceptions, ERISA was to be the controlling law for regulating pension
benefit plans.
The REA also filled certain gaps in ERISA that disadvantaged women,
such as service period calculation rules that penalized women (and
perhaps men) who took time off for pregnancy and child rearing. Another
gap in ERISA allowed the participant spouse (typically, at that time,
the husband) to unilaterally take the pension payments in the form of a
single life annuity. This single life annuity was paid while the
participant was alive and, once the participant died, the hapless widow
would not have much income to live on. Even today, many widows face the
bleak prospect of having to live solely off Social Security benefits
once their husbands' pre-REA pension benefits stop paying.
In light of the enactment of the REA, decisions like Gago
were overruled, and pension division orders would be enforceable only if
they were considered to be a qualified domestic relations order (QDRO)
under ERISA.31 The next section outlines
the formal requirements for a QDRO and issues that practitioners and
judges need to be aware of when dealing with a QDRO.
Enforcing State Court Orders Through Proper Use of QDROs
As amended by the REA, ERISA currently states that a pension plan may
not assign or alienate benefits.32 This
prohibition applies to the creation, assignment, or recognition of a
right to any benefit stemming from a participant's account made under a
domestic relations order (DRO), unless the plan determines that the DRO
is a qualified domestic relations order (QDRO).33 A DRO is any judgment, decree, or order made
under a state's domestic relations law that relates to the rights of
alternate payees (a participant's spouse, former spouse, child, or some
other dependent)34 to all or part of the
participant's pension benefits.35
A DRO is considered a QDRO only if:
1) The order includes the name and the last known mailing address (if
any) of the participant and the name and mailing address of each
alternate payee covered by the order;36
2) The order lists the amount or percentage of the participant's
benefits to be paid by the plan to each alternate payee, or the manner
in which the payment amount or percentage will be determined;37
3) The order lists the number of payments or the time period to which
the order applies;38
4) The order lists each plan to which the order applies;39
5) The order does not require the plan to provide any type or form of
benefit, or any option not already provided by the plan.40 There are, however, three exceptions:41
a) The order may require that the alternate payee's portion be paid
before the participant separates from service or on or after the date on
which the participant attains or would have attained the earliest
retirement age.
b) The order also may require payment as if the participant had
retired on the date on which the payments are to begin, factoring in
only the present value of benefits actually accrued and not taking into
account the present value of any employer subsidy for early
retirement.
c) Finally, the order may require the plan to provide the benefits to
the alternate payee in any form already provided by the plan, except in
the form of a joint and survivor annuity for the alternate payee and his
or her spouse.
6) The order does not require the plan to provide increased benefits
(determined on the basis of actuarial value);42 and
7) The order does not require payments to an alternate payee that
conflict with payments to another alternate payee under a previous
QDRO.43
QDRO Considerations
In enacting ERISA, Congress may have met its goal of creating a
single standard for regulating pension benefit plans; the standard,
however, is not simple. The list of QDRO requirements is just the start
of a complex path, which presents many traps for family law
practitioners. Because the nonparticipant spouse is typically the one
seeking the division of pension benefits, the QDRO drafting burden falls
on that spouse's attorney. If both spouses have pension plans that are
to be part of the marital estate, then both attorneys (assuming there
are two attorneys) will have to play the dual roles of participant's
counsel and nonparticipant's counsel. As a result, both attorneys will
have to take an active part in drafting QDRO provisions for their
client's nonparticipant interests.
Some of the issues that attorneys for nonparticipant spouses need to
keep in mind include:44 making sure all
available pension benefits are discovered; determining the appropriate
value of each pension plan; determining whether any other QDROs are
already recognized by the plan or whether there are beneficiaries other
than the nonparticipant spouse listed on the plan documents;
understanding the plan's QDRO requirements, benefit payment options, and
benefit calculation formulas before drafting a DRO; putting the plan on
notice that a divorce is underway and that a DRO is being drafted;
working with the plan administrator to get a preapproval on the draft
DRO; getting a draft DRO accepted and entered by the circuit court and
presenting a copy of the DRO (even if it is not qualified) to the plan;
and having the final signed DRO formally recognized as a QDRO.
While a plan may offer a model QDRO, attorneys are under no
obligation to use it and likely will need to amend it because a model
QDRO is written from the plan's perspective. The model document may
contain terms that are convenient for the plan administrator but that
hurt the client. For example, a model QDRO might not provide payment
options, such as death benefits, because they are expensive for the plan
to administer.45
When drafting the DRO, an attorney should pay special attention to
the time period at which the nonparticipant spouse obtains the right to
control and have access to the benefits. To avoid post-divorce disputes
regarding how the pension benefits are managed or whether the
participant is intentionally diminishing the value of the pension
benefits, the DRO or QDRO should be drafted to divide the control and
access of the benefits, between the parties, as of the divorce date. If
the participant intentionally diminished benefits before the DRO's
entry, the court should be informed so that the court takes such
misconduct into account when deciding how to divide the marital
estate.46
Other considerations include whether the DRO accounts for dividing
future increases to the participant's benefits through cost of living
increases or incentives for the participant to retire early; whether the
DRO provides for continuing and undiminished benefits if the participant
dies or remarries; the tax impact of benefit distributions; and who will
bear the costs of any reductions in benefits if the pension plan is
terminated and benefits are reduced by the PBGC. Given the complexity
and range of issues, an attorney unfamiliar with ERISA should contact a
QDRO expert and an actuary to assist with drafting and understanding the
plan's financial information.
Attorneys who represent plan participant spouses are spared the
trouble of setting up the groundwork for a QDRO and can play a spoiler
role by identifying ERISA issues that prevent a DRO from becoming a
QDRO. Many times, this task will be made easier by plan administrators
who will reject a DRO that does not conform to the plan's QDRO
requirements. Participants' attorneys will, however, need to play a much
larger role in negotiating the terms of the DRO so that the participant
retains the maximum possible portion of the benefits, captures future
increases, and is able to provide the largest benefit amount to a future
spouse or other beneficiary. Other issues include making sure that the
client understands the responsibilities and impact of the QDRO47 and that the nonparticipant spouse does not
double dip by receiving both a percentage of the pension and a death
benefit from the participant's share after the participant's
death.48
Lastly, judges face a unique problem when dealing with QDRO issues in
pro se divorces. Pro se divorces are on the rise in Wisconsin, with
approximately 70 percent of all divorce actions being pro se. Without
attorneys to help the court understand ERISA and QDROs, judges must be
aware of ERISA rules and must manage the QDRO process by instructing
litigants to produce all relevant employment and pension plan
information and imposing a duty on one of the parties to produce a draft
DRO. Without the benefit of adversarial counsel to negotiate the key DRO
terms, however, the judge now faces a dilemma in how to produce an
equitable marital division while also remaining neutral.49
A judge who remains completely impartial could leave it to the
parties to decide how the pension benefits will be divided and let the
parties live with their choices, especially in instances when a client
can afford an attorney but chooses not to use one. However, self
representation is a Constitutional right50
and taking a buyer beware approach with pro se litigants is hardly fair
to low income divorcees (especially those who fall just outside the
income eligibility guidelines for free legal services through
organizations such as Legal Action of Wisconsin) or unsophisticated
parties who do not understand the legal impact of their choices. For
instance, if a court intended a true 50 percent pension division, it
would be unfortunate if the QDRO failed to include a provision taking
into account future cost of living increases or early retirement
subsidies that do not flow to the nonparticipant spouse.
Conclusion
ERISA limits enforcement of state court orders dividing pension
benefits at divorce to orders that are determined to be a QDRO. In order
to properly draft and implement the terms of a pension division, family
law practitioners, in addition to being familiar with Wisconsin rules,
must factor in ERISA's QDRO rules, the rules and features of each
pension plan to be divided, and federal cases dealing with QDROs. State
court judges also must be familiar with these additional rules and cases
in pro se divorces to ensure their orders can be properly enforced and
executed.
Endnotes
Wisconsin
Lawyer