In addition to dividing retirement plans, Qualified Domestic Relations Orders can be applied to divorce situations involving alimony and child support, including the retrieval of child support arrearages.
By Tim Voit, Financial Analyst
Using Qualified Domestic Relations Orders (QDROs) for dividing retirement plans as marital property between divorcing spouses is commonplace; however, an alternate payee under the Internal Revenue Code (IRC) is defined as a spouse, former spouse, or dependent [IRC §414(p)(8) and ERISA §206(d)(3)(K)]. As a result, QDROs can also be used to pay alimony, child support, or retrieve all or a portion of the child support arrearages from the non-custodial spouse’s retirement plan [IRC §414(p), and §206(d)(3)(B) of ERISA, and 29 U.S.C. §1056(d)(3)(B)].
In the case of child support, the actual amount assigned to the alternate payee in a QDRO should be “grossed-up” to reflect the fact that, for 401(k) plans, the plan administrator is required to withhold 20% for income tax purposes. That is, the court must either order the plan to make a direct distribution to the custodial spouse net of taxes or the amount awarded should be increased 20% to account for the withholding taxes. This is so the custodial spouse does not end up paying taxes on child support that normally wouldn’t be taxable to them.
An Example of Using a QDRO to Collect Child Support
Jo Ellen had not received child support in over ten years on behalf of her four children. She recently obtained a judgment against her ex-husband that determined and specifically set out the amount owed as $160,000 – including actual payments missed, along with statutory interest.
In this case, the QDRO would be drafted awarding Jo Ellen $200,000 as the custodial parent. The actual amount distributed to her as payment of child support arrears would be $160,000, while the remaining $40,000 would be withheld from the participant’s (former husband’s) account for purposes of the 20% income tax liability he incurred.
Representing the Spouse with Child Support Obligations
Conversely, if you represent a divorcing spouse with current child support obligations and who possesses a large but illiquid 401(k) account balance, it may be possible for the child support to be paid directly from his retirement plan each month or semi-annually – thereby enabling him to free up additional monies for normal daily living expenses. For instance, if he is obligated to pay $800 per month in child support, a QDRO could potentially be drafted to have the net amount of $800 per month paid out from his 401(k) without adversely affecting his cash flow. Having his child support obligations periodically withdrawn from the retirement plan without tax penalties, but still subject to the 20% withholding tax, would free up his current cash flow. However, distribution options can be limited in some cases based on the terms and conditions of the plan and may be paid out semi-annually or annually. Although the QDRO must ultimately be signed by the court, the language within the QDRO must be approved (qualified) by the plan administrator. Careful consideration must be given to which spouse the plan administrator intends to assign the tax liability, since many have varying opinions – most notably, the decision to only tax the participant when a minor child is the alternate payee.
Tim Voit is a financial analyst and the president of Voit Econometrics Group. He concentrates on QDROs and QDRO distribution, evaluation of retirement plans, and securities litigation. www.vecon.com