The situation is too often that clients are rich in defined contribution retirement benefits and cash poor. The client wants to hire an attorney to help them achieve an equitable divorce, but they cannot afford the cost of legal services. Many times the opposing party has retirement benefits that seem unreachable before a final judgment is entered. Below is a discussion of the various options afforded the parties in such circumstances:
Option 1— The participant can apply for a distribution with spousal consent and an agreement that this will not violate ATROS. The plan does not have to allow for a distribution if the participant is still working (called an “in-service” distribution) so this may or may not be an option. The participant can find out this information by asking the plan administrator. The participant will need to obtain spousal consent (because the parties are still married) to obtain a distribution. Normally the parties would agree to share equally in the distribution amount, or agree that this amount is charged solely against participant and is trued up in the community property calculation when the asset is divided later in the divorce. The participant will be taxed at ordinary income tax rates plus a 10 percent federal penalty and a 2.5 percent California penalty for taking out these funds if the Participant is under the age of 59 ½. Therefore, this method can be very costly in terms of tax consequences. A divorce case does not need to be opened for this to occur.
Option 2— The participant can apply for a loan with spousal consent and an agreement that this will not violate ATROS. The plan does not have to allow for loans so again the participant needs to ask the plan administrator. Loans are not available unless the participant is still an employee of the plan sponsor and the limit is the lesser of 50 percent or $50,000. The participant will need to obtain spousal consent (because the parties are still married) to obtain a loan. Normally the parties would agree to share equally in the loan proceeds or agree that this amount is charged solely against the participant and is trued up in the community property calculation when the asset is divided later on. The participant will have to make payments on the loan from his
paycheck and those payments are generally his separate property contributions so again, this can be trued up when the asset is divided. The Participant will notbe taxed on the loan so long as he is making payments. Therefore, this method can be the easiest for obtaining liquidity when both parties agree. A divorce case does not need to be opened for this to occur.
Option 3 — The participant and spouse can agree to enter a QDRO assigning a certain sum to the non-employee spouse. The spouse can either retain the funds, remit them to the participant, or share equally in the funds. Whatever is agreed to can be addressed in the true up calculation when the benefits are ultimate divided. The spouse will be taxed on the distribution at ordinary income tax rates but will not pay an early withdrawal penalty. If spouse’s tax bracket is less than the participant’s then this can be a much better way to obtain funds than a straight distribution. A divorce case must be opened for this to occur because the QDRO must be filed with the court, but the QDRO can be done before Judgment.
All of the options discussed are based on the premise that both parties agree to access the retirement benefits for liquidity pending the final Judgment and final QDROs. If the parties cannot agree to one of the options above, the participant or spouse can argue to the court for an order permitting access to plan funds prior to Judgment so long as the request is limited in dollar amount and reasonable to fund litigation. The court can order that the non-employee spouse must provide a signature on a distribution form, loan form, or QDRO as long as you can prove that the amount requested for liquidity for the party does not exceed their half of the community interest. An elisor can also be appointed to sign these forms.
Because there are various mechanisms to accessing retirement benefits pending divorce and ERISA provides that a QDRO is an exception to the anti-alienation and creditor protections afforded to retirement benefits, it follows that arguablyrequesting liquidity from a retirement plan is no different from requesting a distribution from a jointly owned investment account.