Performing a calculation of the community interest in defined contribution plans can save fees
Many clients have more than one defined contribution plan or IRA. Generally speaking, there is not a significant difference between the assets in these accounts and they can be treated as “apples to apples” when dividing retirement benefits.
This means that it can be cost effective for the parties to calculate the community interest in these retirement benefits and do one transfer to equalize the community interest, rather than paying a QDRO attorney to divide each account in kind (with a QDRO prepared for each account.)
Consider an average marriage where each party has a 401(k) plan and an IRA. If a generic QDRO provider is contacted to do the QDROs for these plans and accounts, the fee will be based on four Domestic Relations Orders: one for each 401(k) plan and one for each IRA. Instead, significant fees can be saved for clients if the MSA leaves open the possibility of the QDRO attorney calculating the community interest in each of the 401(k) plans and IRAs, and simply doing one Order to equalize the community interest. Our clients typically see a 50 percent reduction in fees if this approach is utilized.
The approach in the MSA is typically worded as follows:
The parties agree to jointly retain [________________] to divide the community interest in the defined contribution plans and IRAs. The QDRO attorney shall calculate the community interest in the plans and IRAs as of the most recent quarter and prepare one or more Qualified Domestic Relations Orders to equalize the community interest using the most cost-effective method.
Variations of this language are available on most MSA programs and templates. When this approach is utilized, many family law attorneys will send the draft language to the QDRO preparer ahead of time (which is our recommendation) so that any discrepancy or issues with combining these assets can be addressed in the MSA. The most common issue occurs when there is a ROTH IRA (after taxes) in which case the following language can be used:
For purposes of performing the equalization calculation, the QDRO attorney shall gross up the value of any ROTH assets to account for the after-tax treatment of ROTH assets. If the parties cannot agree regarding the gross up value, the ROTH assets shall be equalized in kind.
When dividing retirement benefits, the goal is efficiency and fairness. Allowing for the possibility of a calculation of the community interest and having only one QDRO prepared will allow for a reduction of QDRO attorney fees and still accomplish an equal division of the community interest in all accounts.
Practice tip: It is generally not recommended that defined benefit plans are equalized with defined contribution plans. These are typically regarded as “apples and oranges” due to the fact that defined benefit plans are a monthly benefit payable over a lifetime with no current account balance whereas defined contribution plans have a current account balance invested in the stock market. In mediation and settlement, it is common for there to be an offset of defined benefit plans with defined contribution plans when the parties agree to a specific valuation dollar amount for the defined benefit plan. However, it is uncommon for a judgment to require the offset between a defined contribution plan and a defined benefit plan when the valuation has not been agreed upon due to the potential fluctuation in the present value calculations of defined benefit plans depending on what interest rate and inflation rate assumptions are used.