One of the creative uses of a revocable interest pertains to assigning benefits that terminate upon the passage of time or the happening of a certain event.
By Rick Johnson, Actuary
Most uses of QDROs are for the outright, unconditional assignment of present or future monetary interests in the participant’s benefits to an alternate payee in exchange for his or her marital property rights.
Under Section 1.401(a)-13(c)(1)(ii) of the Income Tax Regulations, the term “assignment” includes any direct or indirect arrangement (whether revocable or irrevocable) whereby a party acquires from a participant or beneficiary a right or interest enforceable against the plan in, or to, all or any part of a plan benefit payment which is, or may become, payable to the participant or beneficiary.
A revocable assignment is an assignment that contains terms and conditions that would cause the assignment of benefits (or assignments such as pre-retirement death benefits) to terminate or change as a result of the passage of time or the happening of some defined event.
Section 414(p)(2) states in part, a domestic relations order meets the requirements….only if such order clearly specifies — (C) the number of payments or period to which such order applies.
Section 414(p)(3) states in part, a domestic relations order meets the requirements… only if such order — (A) does not require a plan to provide any type or form of benefit, or any option, not otherwise provided under the plan,
Traditionally, qualified domestic relations orders involving defined benefit plans, whether qualified, non-qualified or from government plans, have been used to assign separate interest or stream of interest benefits to an alternate payee which were permanent, non-revocable interests. The benefits were generally payable for the life of the alternate payee (or under some other defined term if elected by the alternate payee). When the alternate payee died, the benefits to the alternate payee would cease and the participant’s benefits continued at the reduced rate.
It is possible with the creative use of a revocable interest to assign benefits that terminate upon (1) the passage of time or (2) the happening of a certain event, the result being that the benefits would “pop-up” to the participant, that is, they would return to the full unreduced level. This type of interest can be used to fund alimony agreements, provide for child support payments, provide for security interests or provide for a limited number of benefit payments.
Creative Uses of Revocable Interests and Alimony
Alimony is defined in IRC Section 71 as any payment, (1) in cash or its equivalent, (2) to or for the benefit of a former spouse under a divorce or separation instrument, (3) such instrument does not designate the payments as payments which are not includible in gross income and not allowable as a deduction under IRC Section 215 and (4) there is no liability to make any payments (either in cash or property) as a substitute for such payments after the death of the former spouse. Generally, alimony is an unsecured order or promise to pay. Where a defined benefit plan is in or near pay status, an assignment of an interest in the plan can serve as a funding vehicle for or as a substitute for alimony, in effect converting the alimony from an unsecured order or promise to pay into a guaranteed order or promise to pay. Although uncommon, there is no prohibition in Section 414(p) that would prevent an interest to an alternate payee from terminating upon the death of the alternate payee or any other contingency, such as the remarriage of the former spouse. In order for an assignment of this type to work, the assignment would have to be a stream-of-payments interest, that is, the payments would not begin to the alternate payee until the participant began receiving benefits. The alternate payee would not be able to make any elections under the plan. Upon the happening of the earliest of any contingency contained in the order or agreement, the payments under the plan to an alternate payee would terminate and the benefits would “pop-up” to the participant.
Limited Payments
Occasionally, there is a need, in order to satisfy the needs of one or both of the parties, to create a revocable interest so that the benefits payable to an alternate payee under a defined benefit plan will not terminate upon the death of the alternate payee, but would revert back to the participant. An example would be an assignment to an alternate payee whose life expectancy is likely to be substantially less than the participant’s. This could be a result of a great disparity in their ages or the health of the alternate payee. Where there is the likelihood that the participant will outlive the alternate payee by a number of years, an interest in the participant’s plan can be assigned to an alternate payee contingent upon the death of the alternate payee. The assigned interest would by necessity have to be a stream-of-payments benefit, that is, the payments would not begin to the alternate payee until the participant began receiving benefits. The alternate payee would not be allowed to make any elections under the plan. When the death contingency took place, the payments would “pop-up” to the participant. This type of arrangement could be used as a substitute for a short term alimony arrangements where funding of the alimony is guaranteed by the plan. Under this type of arrangement, the defined benefit plan would have to be near or in pay status.
Security for Alternate Payee’s Benefits Paid to Participant
Every QDRO (or similar order) should contain a provision which makes the participant as a constructive trustee for the receipt of any benefits that are due to be paid to the alternate payee under the order, but which are paid to the participant. The order should also require that the participant pay the benefits to the alternate payee within a specified period of time. Naming the participant as a constructive trustee does not relieve the plan administrator of any liability to pay the benefits under a properly drafted and accepted order.
All qualified plans are required to have procedures in place for the receipt, notice acceptance and rejection of orders served upon it. It is rare that these procedures break down. The alternate payee’s benefits may be paid to the participant for any number of reasons. The most common are (1) no order was transmitted to the plan administrator and (2) after an original order is rejected and the alternate payee has been notified by the plan administrator that the order does not meet the requirements to be qualified, an amended order was not transmitted or was transmitted after benefits have commenced to the participant. Even though the order may require the participant to pay the benefits within a specified period of time, generally the payment of alternate payee’s benefits to a participant creates an enforcement problem. One way to solve this potential problem is to include in the order a provision that requires the plan administrator to withhold from future benefits of the participant until the amounts due to be the alternate payee have been recouped.
Provision to withhold for Alternate Payee’s Benefits Paid to Participant
For a verity of reasons, participants often begin receiving benefits prior to the receipt by the Plan Administrator of an acceptable QDRO. Most QDROs now include constructive trust language which orders the participant to pay to the alternate payee any benefits which were paid to the participant but were due to be paid under the order to the alternate payee. However, this language is nothing more than an unsecured order to pay. If the participant elects not to pay, enforcement problems arise. It is possible to include in a QDRO a make-up provision in the order which foresees the likelihood that the participant will receive benefits that were due to be paid to an alternate payee. The makeup provision directs the Plan Administrator, upon notice by the alternate payee, to withhold payments from the participant to make up the past due payments the participant may owe to the alternate payee under the constructive trust provisions of an order. The make-up provision can only be activated subsequent to the acceptance of a QDRO by the Plan Administrator. Make-up provisions are a form of revocable assignment contemplated by IRC Section 414(p).
Creative Uses of Revocable Interests: Example of an agreed make-up provision
If for any reason the Plan fails to make payments required to the Alternate Payee pursuant to this Order and makes the full payment to the Plan Participant, it is the Plan Participant’s obligation, and Participant hereby agrees to make such payment to the Alternate Payee, and to so notify the Plan Administrator of the error, and to continue to make the required payments to the Alternate Payee until such time as the administrative error is corrected. If the Plan Participant fails to notify the Plan Administrator or fails to make the payments necessary to the Alternate Payee, the Plan Participant hereby authorizes the Plan Administrator to withhold future payments from the Participant’s Plan distributions until such time as the amounts owed to the Alternate Payee are recouped.
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Rick Johnson operates QDRO Services, LLC in The Woodlands, Texas. The company was formed in early 1996 for the purpose of assisting attorneys and their clients with the division of retirement benefits and a QDRO solution when it is necessary.
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