Divorce ~ QDRO Retirement Plans

Dangers of eliminating or having an imperfect Qualified Domestic Relations Order[i]

Sample Language For Spouse's Rights To Survivor Annuities and QDROs - Notice 97-10, Notice 97-11[ii]

The following are from sources to be reliable. Any issue can be challenged by any government authority at its will, and no warranty can be made regarding the results. Any risks are real and any treatment of the issue is the responsibility of the taxpayer.

Introduction

A distribution by a qualified retirement plan to an “alternate payee” who is a spouse or former spouse of the participant is taxable to the spouse, rather than the participant, if it is made pursuant to a “qualified domestic relations order” (QDRO) (Code Sec. 402(e)(1)(A)). An alternate payee is a person who is recognized by a domestic relations order as having a right to receive all or a portion of the participant's benefits under the plan (Code Sec. 414(p)(8)). A domestic relations order is a judgment, decree, or other order of a court issued under the domestic relations or community property law of a state or the District of Columbia that relates to alimony payments, child support, or marital property rights (Code Sec. 414(p)(1)(B)). It includes judicial approval of a property settlement agreement between the spouses. A domestic relations order is “qualified” (is a QDRO) if it satisfies the requirements.

The foregoing rule applies to taxable distributions of all kinds--annuity distributions, in-service distributions, lump-sum distributions, and all others. For special rules that apply in the case of lump-sum distributions and rollover distributions, see ¶¶18,207.048 and 18,922.0925.

What Is A QDRO?

A domestic relations order, under Code Sec. 414(p), is a judgment, decree or order (including approval of a property settlement agreement) made pursuant to a state's domestic relations or community property law and relating to the provision of child support, alimony or marital property rights to a spouse, former spouse, child or other dependent of a plan participant. For such an order to be a qualified order, it must clearly specify--

(1) the name and the last known mailing address (if any) of the participant and the name and mailing address of each “alternate payee” (i.e., the spouse, former spouse, child or dependent who is recognized by the order as having a right to benefits);

(2) the amount or percentage of the participant's benefits to be paid to each alternate payee or the manner in which the amount or percentage is to be determined;

(a) except as noted at .126, below, it requires a plan to provide any type or form of benefit, or any option, not otherwise provided by the plan;

(b) it requires the plan to provide increased benefits (determined on the basis of actuarial value); or

(c) it requires the payment of benefits to an alternate payee that are required to be paid to another alternate payee under a previous qualified order.

With respect to restriction (a), the Senate Finance Committee Report on the Tax Reform Act of 1986 indicates that an order will not fail to be a QDRO even if the form of the benefit does not continue to be a form permitted under the plan on account of a plan amendment or a change of law. In the case of plan amendment, an alternate payee remains entitled to receive benefits in the form specified in the order. In the case of a law change that makes the benefit form specified in the order impermissible, a plan must permit the alternate payee to select a form of benefit specified in the plan. In either case, the elected form cannot affect, in any way, the amount or form of benefits payable to the participant.

The Senate Committee Report on REA makes it clear that an order need not furnish the mailing address of an alternate payee if the plan administrator has reason to know that address (e.g., where the alternate payee is also a plan participant). It also makes it clear that an order is not considered to provide “increased benefits” unless it provides for the payment of benefits in excess of those to which the participant would be entitled in the absence of the order. The Committee Report states that a QDRO will remain qualified with respect to a successor plan of the same employer or a plan of a successor employer (within the meaning of Code Sec. 414(a)). Finally, the Senate Finance Committee Report includes the following remark: “During any period in which the alternate payee cannot be located, the plan is not permitted to provide for the forfeiture of the amounts that would have been paid unless the plan provides for full reinstatement when the alternate payee is located.”

Period to which order applies. Questions are raised by the requirement that a QDRO specify the number of payments or the period to which the order applies. For example, a common alimony order requires payments “until further order of the court.” Does this order specify the period to which the order applies? Again, in a property division, the court may order that the nonemployee spouse is to receive a specified percentage of whatever benefits are paid with respect to the employee, whenever and however they may be paid. Does such an order specify the period to which it applies?

For the above and other reasons, it is of the utmost importance that any divorce court ordering a deferred division of benefits retain jurisdiction to clarify the order in the event that it should meet with a narrow interpretation at the hands of a plan administrator.

Alternative forms of benefits: Whose choice? Although neither the law nor its legislative history is informative on the point, it seems that the definition of a QDRO is broad enough to include any order under which the plan must provide a nonemployee spouse with his share of the employee's benefits in any form authorized by the plan (at the election of the nonemployee spouse). In other words, it does not appear that the divorce court is restricted to awarding to the nonemployee spouse an amount or percentage of a benefit that is elected by the employee. The legislation generally does not impose any restrictions on the power of divorce courts to divide benefits, and the early retirement rule (see .126, below) clearly contemplates awarding a benefit to the nonemployee spouse (other than a joint and survivor annuity with a subsequent spouse) that has not been elected by the employee.

Descendibility of benefits. In some states retirement benefits awarded to a nonemployee spouse are held to be descendible. That is, upon the death of that spouse, his share of the employee's benefits may pass to legatees by will or to heirs if there is no will. If the order of the divorce court is silent on this matter, there is a strong possibility that any such payments to an heir or legatee would not be construed to be made pursuant to a QDRO or a domestic relations order of any kind. Even if the court's order specifically provides for descendibility, payments could be made only to a “child or other dependent” of the employee, because a payment to any other person is excluded by the definition of a qualified domestic relations order.

Order directed to whom? In the past, many state courts have assumed that the only manner in which benefits could be made available to a nonparticipant was by means of a personal order directed to the employee to pay, upon receiving them, a portion of those benefits to the nonparticipant. This assumption was certainly correct where the plan had not been made a party to the proceedings. REA, by its terms, does not require that a QDRO be directed to the administrator of the plan. It requires only that the order create or recognize the existence of an alternate payee's right to, or assign to an alternate payee the right to, all or a portion of the benefits payable with respect to a participant under a plan. Under this definition there appears to be no reason why an order directed to the employee may not be enforced as against a plan administrator. Conservative practice, however, dictates that the order specifically provide for enforcement against the plan administrator. (Compare 5 CFR §831.1703, wherein a statute governing the division of civil service retirement benefits was construed by the Office of Personnel Management to require that a qualifying court order demonstrate a clear intent that benefits be payable directly to a nonparticipant by the government. That regulation also holds that an order directing a participant to make payment to a former spouse does not evidence such an intent.)

IRS sample language and guidance. Section 1457(a)(2) of the Small Business Job Protection Act directed the IRS to develop sample language for inclusion in a form for a qualified domestic relations order described in Code Sec. 414(p)(1)(A) (and ERISA Section 206(d)(3)(B)(i)) which meets the minimum requirements of these provisions and focuses attention on the need to consider the treatment of any lump sum payment, qualified joint and survivor annuity, or qualified preretirement survivor annuity. The IRS complied with this mandate in Notice 97-11, I.R.B. 1997-2, 50, (97(16) ¶46,223). The Notice provides information intended to assist domestic relations attorneys, plan participants, spouses and former spouses of participants, and plan administrators in drafting and reviewing a QDRO. Sample language that may be included in a QDRO is provided and a variety of drafting issues are discussed.

A distribution to a spouse by a qualified plan that is a governmental plan (as defined in Code Sec. 414(d)) or a church plan (as defined in Code Sec. 414(e)) is taxable to the spouse if it is made pursuant to a domestic relations order. The order need not be a “qualified” domestic relations order (Code Sec. 414(p)(11)). The same rule applies in the case of: (1) a qualified plan that has not, after September 2, 1974, provided for employer contributions; and (2) a qualified plan established by a fraternal order or voluntary employee's beneficiary association (VEBA) to which employers do not contribute (Code Sec. 414(p)(9) and (11)).

If a distribution to a spouse or former spouse is not made pursuant to a QDRO (or, in the case of the plans referred to in the preceding paragraph, is not made pursuant to a domestic relations order of any kind), the certain provisions[iii] do not apply.

Community Property Laws

Since enactment of the Retirement Equity Act of 1984 (REA), several courts have held that state community property laws, standing alone, cannot deprive an employee participant of any part of his interest in benefits accumulated under a plan subject to ERISA. Under the provisions of ERISA (as amended by REA) community property laws are preempted and the nonemployee spouse can acquire an interest in the employee's benefits only through a qualified domestic relations order

Distributions Eligible For Rollover

A-12: (a) Spousal distributee. If any distribution attributable to an employee is paid to the employee's surviving spouse, section 402(c) applies to the distribution in the same manner as if the spouse were the employee. The same rule applies if any distribution attributable to an employee is paid in accordance with a qualified domestic relations order (as defined in section 414(p)) to the employee's spouse or former spouse who is an alternate payee. Therefore, a distribution to the surviving spouse of an employee (or to a spouse or former spouse who is an alternate payee under a qualified domestic relations order), including a distribution of ancillary death benefits attributable to the employee, is an eligible rollover distribution if it meets the requirements of section 402(c)(2) and (4) and Q&A-3 through Q&A-10 and Q&A-14[iv] of this section. However, a qualified plan (as defined in Q&A-2 of this section) is not treated as an eligible retirement plan with respect to a surviving spouse. Only an individual retirement plan is treated as an eligible retirement plan with respect to an eligible rollover distribution to a surviving spouse.

Alternate payee under qualified domestic relations order. You may be able to roll over all or any part of a distribution from a qualified employer plan that you receive under a qualified domestic relations order (QDRO). If you receive the distribution as an employee's spouse or former spouse under a QDRO, the rollover rules apply to you (the alternate payee) as if you were the employee. You can rollover the distribution from the plan into a traditional IRA or to another eligible retirement plan.

Divorce and separation.-- Other

As discussed at .03, a key element in the definition of a lump-sum distribution is that the distributee must, within one tax year, receive the entire balance to his or her credit in the plan. In applying this provision, the portion of the participant's account that is earmarked for a spouse or former spouse pursuant to a qualified domestic relations order (QDRO) is ignored (Code Sec. 402(d)(4)(H)). For the definition of a qualified domestic relations order, see “What is a QDRO?”.

Example: Randall Ralston is a participant in the profit-sharing plan of Acorn Corporation. He was born before 1936. On August 1, 1994, he terminates his employment with Acorn and requests a distribution of all amounts due him by the plan. The balance standing to his account is $100,000, but, pursuant to a QDRO, $50,000 is distributable to his ex-wife, Rose, upon Randall's termination of employment. Therefore, Randall receives only $50,000. Even though this does not represent the entire benefit accrued by him under the plan, Randall is treated as having received the entire balance to his credit as of the date of his termination of employment. Accordingly, it is eligible for special tax treatment.

The law provides that, if any distribution of the balance to the credit of a participant would be treated as a lump-sum distribution, the payment under a QDRO of so much of that balance as has been earmarked for the participant's spouse is treated as a lump-sum distribution. For this purpose, the balance to the credit of the spouse does not include any amount payable to the participant (Code Sec. 402(d)(4)(J)). This provision is not a model of draftsmanship, and little help in its interpretation is provided by the legislative history. (The Conference Report No. 100-1104, 100th Cong., 2d Sess. 168) (Technical and Miscellaneous Revenue Act of 1988 (P.L. 100-647)) reads as follows: “The conference agreement makes income averaging available with respect to distributions to an alternate payee who is a spouse or former spouse of the employee. In particular, the conference agreement provides that if a distribution of the balance of the credit to the employee would constitute a lump-sum distribution, then a distribution of the balance of the credit to the alternate payee constitutes a lump-sum distribution. In determining whether the distribution consists of the balance to the credit of the alternate payee, only the interest of the alternate payee is taken into account.” Although the matter is not free from doubt, it appears that the entire portion of the participant's accrued benefits that is payable to a spouse pursuant to a QDRO is treated as a lump-sum distribution to that spouse if it would be so treated if paid to the participant (assuming that it was the entire amount due the participant). If this is correct, the distribution to the spouse must (1) represent the entire amount earmarked for the spouse by the QDRO, (2) be paid within one tax year of the spouse, and (3) be paid on account of the participant's death or separation from service or after the participant's disability or attainment of age 591/2. The IRS Publication on divorce and separation appears to embrace this view, as does the Publication on pension and annuity income. IRS Publication 504, Tax Information for Divorced or Separated Individuals, p. 11, states : “The spouse or former spouse can use the special rules for lump-sum distributions (special averaging method or capital gain treatment) if, had the participant received the benefits, they would have been treated as a lump-sum distribution.” IRS Publication 575, Pension and Annuity Income, p. 17, states: “If you receive a distribution as an alternate payee under a qualified domestic relations order * * *, you may be able to choose the special tax treatment for it. You can make this choice for a distribution that would be treated as a lump-sum distribution if received by your spouse or former spouse (the plan participant).”

It may be argued that the status of a distribution to a spouse should not be linked to the participant's age, employment, or mortality and that the spouse should be entitled to special tax treatment in any case where the entire amount to which he or she is entitled under a QDRO is received within a single tax year. However, the first clause in the statute (“If any distribution or payment of the balance to the credit of an employee would be treated as a lump-sum distribution * * *”) implies that the status of the distribution is tied to the participant's age, employment, or mortality.

The legislative history of the provision refers only to the spouse becoming eligible for “averaging.” However, the language of the statute implies that the spouse is eligible to treat the distribution in any manner in which the participant could treat it. This being so, the spouse should also be entitled to elect a flat 20% tax for the taxable amount of the pre-1974 portion (if any) of the distribution, provided that the participant was age 50 before 1986 (see .01).

TSA Information

The rules relating to divorce-related distributions from a qualified plan to a participant's spouse or former spouse pursuant to a qualified domestic relations order (QDRO) likewise apply in the case of such distributions from a TSA, except as may be otherwise provided in regulations (Code Sec. 414(p)(9) (last sentence)). Such regulations have not yet been adopted or proposed, but an explanation by the Joint Committee on Taxation states that, because the anti-assignment rules of Code Sec. 401(a)(13) do not apply to TSAs, it may be appropriate for the Treasury to exempt such annuities from some of the procedural requirements discussed at ¶17,733.123 (Description of Technical Corrections Act of 1988 (H.R. 4333 and S. 2238), prepared by the staff of the Joint Committee on Taxation, March 31, 1988, reprinted as CCH Special 1, Extra Edition of Standard Federal Tax Reports No. 19, April 6, 1988).

The QDRO rules that apply to TSAs include the distribution rules discussed at ¶6140.125 et seq., ¶18,217A.06, and ¶18,922.0925 other than the provision extending capital gain and averaging treatment to spouses or former spouses of participants in qualified plans. Since participants in TSAs are themselves not eligible for capital gain or averaging treatment, it seems inconceivable that Congress intended that their spouses or former spouses be eligible for such treatment (a literal reading of Code Sec. 414(p)(9) might suggest otherwise). Other QDRO rules include:

(1) an exception to the distribution limitations of Code Sec. 403(b)(11) (see .044) (Code Sec. 414(p)(10)), and

(2) exemption from the excise taxes on early distributions and excess distributions (Code Secs. 72(t)(3)(A) and 4980A(e)) (see .0322 and .0324).

__________ [Respondent's Name] __________ JUDICAL DISTRICT AND IN THE INTEREST OF

This QUALIFIED DOMESTIC RELATIONS ORDER NUMBER __________ is intended to meet the requirements for a ``qualified domestic relations order'' relating to the __________, hereinafter called the ``Plan,'' as set forth in Chapter 76, Title 110B, Vernon's Texas Civil Statutes (V.T.C.S.), as added by Section 1, Chapter 616 (SB 187), Acts of the 71st Texas Legislature, Regular Session, 1989. This order is an integral part of the FINAL DECREE OF DIVORCE signed on the day of __________, 19__. In compliance with those requirements, the following are specified:

1. This Order assigns a portion of the benefits or amounts payable under the Plan to __________ [Petitioner's Name] in recognition of her marital rights in __________ [Respondent's Name] benefits or amounts payable under the Plan.

2. Participant in the Plan is __________ [Respondent's Name] whose last known mailing address is __________, and whose social security number is __________.

3. Alternate Payee is __________ whose last known mailing address is __________, and whose social security number is __________.

4. As part of a just and right division of the estate of the parties, Alternate Payee is awarded and shall receive from the Plan a portion of each distribution of retirement benefits (whether payable to Participant or a beneficiary) and death or survivor benefits (including distribution of the remaining balance of Participant's accumulated contributions paid as a death benefit) if, as, and when such distributions are made as provided by the plan's governing laws and rules based on Participant's membership in, credit with, or contributions to the Plan. Alternatively, in lieu of these benefits, Alternate Payee is awarded and shall receive from the Plan a portion of the distribution of Participant's total accumulated contributions to the plan, if as, and when such distribution is made as provided by the Plan's governing laws and rules. The term ``accumulated contributions'' as used in this Order is defined by Section 821.001(1), Texas Government Code, or its successor statute.

The portion of the distribution of benefits or total accumulated contributions that is awarded and that is to be paid to Alternate Payee shall be FIFTY PERCENT (50%) of the total accumulated value of the Plan for the period beginning with the date of marriage, which is __________, and the date of divorce, which is __________, 19 __.

5. The Administrator of the Plan is directed to disburse to Alternate Payee the portion of distributions assigned under Paragraph No. 4 of this Order, if, as, and when such distributions are made as provided by the Plan's governing laws and rules based on Participant's membership in, credit with or contributions to the Plan, subject to the following provisions:

(a) This Order shall not be interpreted in any way to require the Plan to provide any type or form of benefit or any option not otherwise provided under the Plan.

(b) This Order shall not be interpreted in any way to require the Plan to provide increased benefits determined on the basis of actuarial value.

(c) This Order shall not be interpreted in any way to require the Plan to pay any benefits to an Alternate Payee named in this Order which are required to be paid to another Alternate Payee under another order previously determined to be a qualified domestic relations order.

(d) This Order shall not be interpreted in any way to require the payment of benefits to Alternate Payee before the retirement of Participant, the distribution of a withdrawal of contributions to Participant as authorized by the statues governing the Plan, or any other distribution required by law.

(e) If the Plan provides for a reduced benefit upon ``early retirement,'' this Order shall be interpreted to require that, in the event of Participant's retirement before normal retirement age, the benefits payable to Alternate Payee shall be reduced proportionately.

(f) This Order shall not be interpreted to require the designation of a particular person as the recipient of benefits in the event of Participant's death or to require the selection of a particular benefit payment plan or option. However, notwithstanding the provisions of this Order, if Alternate Payee is designated as a beneficiary for any benefits payable by the Plan upon the death of Participant, then Alternate Payee shall receive such payment to which she is entitled by law as beneficiary. If Alternate Payee is a joint beneficiary for a benefit, Alternate Payee shall receive the portion of the total benefit payable to the joint beneficiaries as specified in Paragraph No. 4 above; the portion of the benefit payment received by Alternate Payee as a joint beneficiary of Participant shall be credited toward satisfying the amount of the benefit payable to Alternate payee as the alternate payee for Participant's interest. Additionally, as specified in Paragraph No. 4 above, Alternate Payee shall receive a portion of any other benefits which are payable to a beneficiary and for which Alternate Payee was not designated as a beneficiary.

(g) In the event that, after distribution of a benefit to Participant or a beneficiary has begun, the amount of the distribution is increased or reduced by law, then the amount payable to Alternate Payee shall be increased or reduced proportionately.

(h) If the Administrator of the Plan has provided by rule that, in lieu of paying an alternate payee the interest awarded by a qualified domestic relations order, the Plan may pay an alternate payee an amount that is the actuarial equivalent of such interest in the form of (1) an annuity payable in equal monthly installments for the life of the alternate payee, or (2) a lump sum, then and only in that event Alternate Payee or Participant may request the Plan to make payment in this form, and the Plan is authorized to make payment in this form instead of in the manner otherwise described in this Order. This Order shall not be interpreted in any way to require the Plan to adopt such rules or to require the Plan to grant any request for payment in the form described in this provision. The determination of whether to pay an amount authorized by this provision in lieu of the interest otherwise awarded in this Order shall be at the sole discretion of the Plan.

(i) The interest of Alternate Payee is governed by Section 78.001, Title 110B, V.T.C.S, or its successor statute.

6. Any amounts payable by the Plan, other than those payable under Paragraph No. 4 above to Alternate Payee shall be payable directly to Participant, Participant's beneficiary, or the estate, heirs, or legatees of either, in accordance with the Plan rules. If Participant, Participant's beneficiary, or the estate of either receives any amount of a distribution that has been awarded to Alternate Payee, the recipient is designated a constructive trustee for the amount received and shall immediately transmit such amount to Alternate Payee.

7. If Alternate Payee or the estate, heirs, or legatees of Alternate Payee receive any amount of a distribution that should have been paid to Participant, Participant's beneficiary, or the estate, heirs, or legatees of either, the recipient is designated a constructive trustee for the amount received and shall immediately transmit such amount to Plan Participant or other person to whom the amount should have been paid.

If Participant, Alternate Payee, or the estate, heirs, or legatees of either receive any amount of a distribution that should not have been paid by the Plan, the recipient is designated a constructive trustee for the amount received and shall immediately transmit such amount to the Plan Administrator.

8. Alternate Payee is ORDERED to report any payments received on any applicable income tax return in accordance with Internal Revenue Code provisions or regulations in effect at the time any payments are issued by the Plan. The Plan is authorized to issue a Form W‑2P, Form 1099R, or other applicable form on any direct payment made to Alternate Payee. Plan Participant and Alternate Payee shall allocate Participant's investment in contract in the manner established by the Internal Revenue Code and any applicable regulations.

9. Alternate Payee is ORDERED to provide the Plan prompt written notification of any changes in Alternate Payee's mailing address. The Plan shall not be liable for failing to make payments to Alternate Payee if the Plan Administrator does not have a current mailing address for Alternate Payee at time of payment.

10. Alternate Payee shall furnish a certified copy of this Order to the Plan Administrator.

11. The Court retains jurisdiction to amend this Order so that it will constitute a qualified domestic relations order under the Plan even though all other matters incident to this action or proceeding have been fully and finally adjudicated. If the Plan determines at any time that changes in the law, the administration of the Plan, or any other circumstances make it impossible to calculate the portion of a distribution awarded to Alternate Payee by this Order and so notifies the parties, either or both parties shall immediately petition the Court for reformation of this Order.

Case Example

[Retirement plans: Early distributions: 10 percent tax: Qualified domestic relations orders: Qualification as.]P received a lump-sum distribution from two accounts under a qualified pension plan in 1991. Pursuant to a divorce decree entered shortly thereafter, part of the distribution was used to pay off the mortgage on P's former residence and to pay his ex-wife $30,000. P reported the distribution as income on his 1991 Federal income tax return, but included the amount used to satisfy his mortgage obligation and the amount paid to his ex-wife as part of an alimony deduction. R disallowed the alimony deduction and determined that P is taxable on the entire distribution. P contends that he is not liable for tax on the portion of the distribution paid to his former wife and the portion used to satisfy the mortgage because the payments were made pursuant to a qualified domestic relations order (QDRO), as defined by sec. 414(p), I.R.C. Held: The divorce decree rendered after the lump-sum distribution to P does not meet the requirements of sec. 414(p), I.R.C., and is thus not a QDRO. Therefore, P is liable for tax on the entire lump-sum distribution. Held, further, P is liable for additional tax on the entire lump-sum as a result of the early distribution from a qualified retirement plan pursuant to sec. 72(t), I.R.C.

John L. Onesto, Columbus, Ohio, for the petitioner. Donald K. Rogers and Matthew J. Fritz, for the respondent.

Respondent determined a deficiency in the 1991 Federal income tax of petitioner Jerry L. Burton in the amount of $53,916, stemming from funds received by petitioner in connection with the closing of his retirement benefits accounts. A petition was filed on April 24, 1995. An Answer was filed on June 13, 1995. Respondent thereafter filed an Amendment to Answer, claiming an increased deficiency of $17,676 based upon section 72(t).

Unless otherwise indicated, all section references are to sections of the Internal Revenue Code in effect for the year in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.

The sole issue for decision is whether the portion of petitioner's retirement account distribution used to pay off the mortgage on petitioner's former residence and to pay his ex-wife $30,000 pursuant to their divorce decree constituted taxable income to petitioner in the amount of $156,099.46 for 1991.

This case was submitted to the Court on a full stipulation of facts, which are so found. The stipulation of facts and the attached exhibits are incorporated herein by this reference. At the time the petition was filed, petitioner resided in Jackson, Ohio.

Petitioner's employment with Fluor Daniel, Inc. (Fluor Daniel) was terminated on March 8, 1991. Petitioner subsequently divorced Linda Gayle Burton (Mrs. Burton) on June 11, 1991; an “Agreed Decree of Divorce” (Decree) was entered with the District Court of Denton County, Texas. The Decree divested petitioner of his entire interest in his former residence located at 2707 Daybreak Drive, Dallas, Texas (2707 Daybreak Drive), and transferred that interest to Mrs. Burton. The Decree also required petitioner to withdraw his entire retirement account balances at Fluor Daniel, use the proceeds to pay off the mortgage on 2707 Daybreak Drive (for which petitioner was personally liable), and pay Mrs. Burton the remaining balance in an amount not to exceed $30,000. The Decree states that petitioner “shall be responsible for all taxes due on the lump sum retirement withdrawal, and releases *** [Linda] from any and all liability concerning the taxes on the retirement withdrawal.”

The Fluor Daniel retirement plan is and was, at the time of petitioner's participation, subject to the requirements of the Employee Retirement Income Security Act of 1974 (ERISA), Pub. L. 93-406, 88 Stat. 829, as amended. Petitioner had two separate retirement accounts at Fluor Daniel, the “Retirement Plan” and the “Savings Investment Plan.” Sometime in March of 1991, petitioner asked the plan administrator at Fluor Daniel to distribute to him the entire balance of each retirement account. By letters dated May 7 and May 13, 1991, the plan administrator acknowledged petitioner's request and reported to him the amounts to be distributed based on a valuation date of March 31, 1991. As of that date, the combined value of the Retirement Plan and the Savings Investment Plan accounts (plan balance) was $176,754.88. Petitioner received this sum sometime at the end of May 1991 in the form of two checks dated May 24, 1991 and issued by The Northern Trust Company. At the time petitioner received the checks, he was under the age of 59-1/2 and did not attain that age at any time during 1991. The record does not disclose whether petitioner had attained age 55. See sec. 72(t)(2)(A)(v).

Petitioner paid off his mortgage debt on 2707 Daybreak Drive by wire transfer of $126,099.46 from his account at BancOhio National Bank (BancOhio) to his mortgage account at Bank One Dallas on June 6, 1991. Furthermore, on or about July 31, 1991, petitioner sent Mrs. Burton a check drawn on petitioner's account at BancOhio in the amount of $30,000 to fulfill his obligation under the Decree.

On his 1991 Federal income tax return, petitioner reported the plan balance as dividend income of $138,418.91 and capital gain income of $38,335.97. Petitioner also claimed an alimony deduction with respect to both the $30,000 that he paid directly to Mrs. Burton and the $126,099.46 he paid to satisfy the mortgage on 2707 Daybreak Drive. Petitioner included this amount as part of the total alimony deduction of $175,394.07 claimed on the return. The parties have stipulated that petitioner's allowable alimony deduction for the taxable year 1991 was $5,425.

In the Amendment to Answer referred to above, the asserted increased deficiency of $17,676 represents the imposition of additional tax under section 72(t) on petitioner's premature retirement benefits distribution of $176,754.88. Since respondent asserts an increased deficiency, she has the burden of proof on this issue. Rule 142(a). However, the parties stipulated that $20,655.42 of that distribution is taxable income to petitioner. The parties further stipulated that if the Court holds that the total amount of the retirement accounts distribution ($176,754.88) is taxable to petitioner, then petitioner is liable for the additional tax under section 72(t).

We must decide whether the Decree is a qualified domestic relations order (QDRO) within the meaning of section 414(p), thus relieving petitioner of liability for tax pursuant to section 402(a)(9) on the $156,099.46 portion of the lump-sum distribution used to satisfy his mortgage and pay his ex-wife, and the $17,676 additional tax under section 72(t). For the reasons which follow, we hold that the Decree does not constitute a QDRO.

Ordinarily, any funds distributed from an exempt employees' trust (under a tax qualified employees' plan) are taxable to the plan participant or beneficiary who is entitled to receive the distribution under the plan. Darby v. Commissioner [Dec. 47,484], 97 T.C. 51, 58 (1991). However, section 402(a)(9) (now section 402(e)(1)(A)) states an exception to this general rule, providing that an alternate payee (who is the spouse or former spouse of the plan participant) shall be treated as the distributee of any distribution or payment made to such payee under a QDRO. Accordingly, the tax liability for the distribution from the Fluor Daniel retirement accounts will be allocated either to petitioner or to Mrs. Burton depending upon whether the Decree meets the statutory definition of a QDRO.

The Retirement Equity Act of 1984 (REA), Pub. L. 98-397, sec. 204(b), 98 Stat. 1445, added section 414(p), which defines a QDRO. Section 414(p) provides, in pertinent part, the following:

SEC. 414(p). Qualified Domestic Relations Order Defined.--For purposes of this subsection and section 401(a)(13)--

(A) Qualified Domestic Relations Order.--The term “qualified domestic relations order” means a domestic relations order--

(i) which creates or recognizes the existence of an alternate payee's right to, or assigns to an alternate payee the right to, receive all or a portion of the benefits payable with respect to a participant under a plan, and

(B) Domestic Relations Order.--The term “domestic relations order” means any judgment, decree, or order (including approval of a property settlement agreement) which--

(i) relates to the provision of child support, alimony payments, or marital property rights to a spouse, former spouse, child, or other dependent of a participant, and

(ii) is made pursuant to a State domestic relations law (including a community property law).

(2) Order Must Clearly Specify Certain Facts.--A domestic relations order meets the requirements of this paragraph only if such order clearly specifies--

(A) 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,

(B) the amount or percentage of the participant's benefits to be paid by the plan to each such alternate payee, or the manner in which such amount or percentage is to be determined,

(3) Order May Not Alter Amount, Form, Etc, Of Benefits.--A domestic relations order meets the requirements of this paragraph 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,

(B) does not require the plan to provide increased benefits (determined on the basis of actuarial value), and

(C) does not require the payment of benefits to an alternate payee which are required to be paid to another alternate payee under another order previously determined to be a qualified domestic relations order.

Thus, to qualify as a QDRO, a domestic relations order must meet the following tests: First, it must be a domestic relations order that creates, recognizes, or assigns, to an alternate payee, rights under a qualified employee benefit trust otherwise payable to a plan participant. Second, the QDRO must clearly specify certain facts, namely, the names and last known mailing addresses of the participant and the alternate payee; the amount or percentage of the benefits to be paid or the manner in which such amount or percentage is to be determined; the number of payments; and each plan to which the order applies. Third, the QDRO may not alter the amount, form, etc., of the benefits.

Generally, benefits under qualified plans are subject to prohibitions against assignment or alienation (so-called “spendthrift provisions”). S. Rept. 98-575, at 19 (1984), 1984-2 C.B. 447, 456. Before the enactment of section 414(p), the IRS had ruled that the spendthrift provisions are not violated when a plan trustee complies with a court order requiring the distribution of benefits of a participant in “pay status” to the participant's spouse or children in order to meet the participant's alimony or child support obligations, but the IRS had taken no position with respect to this issue in cases in which the participant's benefits are not in pay status. The Senate report indicates that section 414(p) was enacted “to provide rational rules for plan [administrators]”. Id. Congress believed it necessary to establish guidelines for determining whether the exception to the spendthrift rules applies, to ensure that only those domestic relations orders that are excepted from the spendthrift provisions are not preempted by ERISA. Id.

The facts in this case do not comport with the requirements of section 414(p)(1). Petitioner's employment with Fluor Daniel was terminated on March 8, 1991. During that same month petitioner asked the Fluor Daniel plan administrator to distribute to him--petitioner--the entire plan balance. In mid-May of that year the plan administrator acknowledged petitioner's request and reported to him the amounts to be distributed based upon a March 31 valuation date. Petitioner received two checks, both dated May 24, 1991, which terminated his interest in the plan. It is not clear why the plan administrator agreed to this termination of petitioner's entire interest in the plan; one possibility is that the termination of petitioner's interest was permissible as being related to his separation from service with Fluor Daniel. In any event, since the plan proceeds were distributed to petitioner and not to Mrs. Burton, and in advance of the Decree (which was dated June 11, 1991), it cannot be argued that the distribution was made by the plan administrator to an alternate payee in response to the Decree.

Rodoni v. Commissioner [Dec. 50,765], 105 T.C. 29 (1995), involved a similar situation. The domestic relations order in dispute in that case was not executed until after the taxpayer had received a lump-sum distribution terminating his interest in a profit sharing plan. We held that the domestic relations order in that case could not create or recognize rights that no longer existed at the time of the order. Id. at 35. The same is true in this case. See also to the same effect Karem v. Commissioner [Dec. 49,091], 100 T.C. 521 (1993).

Nowhere is there any indication that the Decree was presented to the plan administrator, even in draft form, prior to the distribution of the plan proceeds to petitioner. We have stated, in Rodoni v. Commissioner, supra at 36, that implicit in the procedural rules relating to employee benefit plan provisions (contained in sections 414(p)(6)(B) and 414(p)(7)(B)) is the requirement that a domestic relations order be presented to the plan administrator and adjudged “qualified” before any distribution is made by the plan to the spouse or former spouse. There is no evidence that this occurred in the case before us.

For the foregoing reasons, we hold that the Decree did not effectively create or recognize Mrs. Burton's right as an alternate payee, within the meaning of section 414(p), to receive petitioner's qualified plan benefits. The directions in the Decree to turn over the disputed part of the plan proceeds could only have been effectively addressed to petitioner, who already had the proceeds, and not to the plan administrator. As a consequence of this holding, the total amount of the plan distribution to petitioner is taxable to him in 1991.

Having so held, we do not reach the question of whether the Decree clearly specifies facts as required by section 414(p)(2), or alters the amount, form, etc., of the benefits, as prohibited by section 414(p)(3).

In Hawkins v. Commissioner [96-1 USTC ¶50,316], 86 F.3d 982 (10th Cir. 1996), the Court of Appeals disagreed with our holding in Hawkins v. Commissioner [Dec. 49,638], 102 T.C. 61 (1994), that the domestic relations order in that case did not create or recognize the existence of an alternate payee's right, or assign to an alternate payee the right, to receive employee plan benefits, and did not satisfy the clearly specified facts requirement of section 414(p)(2). However, in that case the disputed domestic relations order preceded the plan distribution, which makes this case distinguishable from Hawkins in a way that is fatal to petitioner's position. The Court of Appeals in Hawkins v. Commissioner [96-1 USTC ¶50,316], 86 F.3d at 990-991, itself recognized a similar disabling distinction under the facts of Karem v. Commissioner [Dec. 49,091], 100 T.C. 521, 523 (1993):

In Karem [v. Commissioner [Dec. 49,091], 100 T.C. 521 (1993)], a consent judgment was entered by a state divorce court in order to partition the community property of Mr. and Mrs. Karem. 100 T.C. at 523. The consent judgment provided that Mrs. Karem was to receive an interest in her ex-husband's pension plan, but it stated the following condition:

“She shall receive that interest pursuant to a qualified Domestic Relations Order to be prepared by Robert Louis Karem. Until the Qualified Domestic Relations Order is completed, Robert Louis Karem shall pay Barbara Wiechman Karem her interest in the pension plan immediately when he receives it.”

Id. After being assessed a deficiency in his gross income based on a lump-sum plan distribution paid to Mrs. Karem, Mr. Karem filed a petition in the Tax Court arguing that the consent judgment was a QDRO. The court rejected this argument, noting that “the consent judgment directs that a QDRO be drafted ***; the consent judgment itself is not a QDRO.” Id. at 525-526 ***.

The Court of Appeals went on to observe that there was thus no written order in existence at the time of the distribution that would satisfy the requirements of section 414(p). Hawkins v. Commissioner, supra at 991.

On brief petitioner argues that he received the plan benefits as agent for Mrs. Burton. However, since the Decree did not qualify as a QDRO, the possibility raised by this argument becomes moot.

As noted above, the parties stipulated that if the Court holds that the total amount of the retirement accounts distribution is taxable to petitioner, then petitioner is also liable for the additional tax under section 72(t). Consistent with this stipulation, we so hold.

^* This case was reassigned to Judge Arthur L. Nims, III, by Order of the Chief Judge.

Internal Revenue Code {CFR Title 26}

Sec. 72 ANNUITIES Subsec. (t) 10-Percent Additional Tax on Early Distributions from Qualified Retirement Plans.--

72(t)(1) Imposition of additional tax.--If any taxpayer receives any amount from a qualified retirement plan (as defined in section 4974(c)), the taxpayer's tax under this chapter for the taxable year in which such amount is received shall be increased by an amount equal to 10 percent of the portion of such amount which is includible in gross income.

72(t)(2) Subsection not to apply to certain distributions.--Except as provided in paragraphs (3) and (4), paragraph (1) shall not apply to any of the following distributions:

72(t)(2)(A)(i) made on or after the date on which the employee attains age 591/2,

72(t)(2)(A)(ii) made to a beneficiary (or to the estate of the employee) on or after the death of the employee,

72(t)(2)(A)(iii) attributable to the employee's being disabled within the meaning of subsection (m)(7),

72(t)(2)(A)(iv) part of a series of substantially equal periodic payments (not less frequently than annually) made for the life (or life expectancy) of the employee or the joint lives (or joint life expectancies) of such employee and his designated beneficiary, or

72(t)(2)(A)(v) made to an employee after separation from service after attainment of age 55, or

72(t)(2)(A)(vi) dividends paid with respect to stock of a corporation which are described in section 404(k).

72(t)(2)(B) Medical expenses.--Distributions made to the employee (other than distributions described in subparagraph (A) or (C)) to the extent such distributions do not exceed the amount allowable as a deduction under section 213 to the employee for amounts paid during the taxable year for medical care (determined without regard to whether the employee itemizes deductions for such taxable year).

72(t)(2)(B) Medical expenses.--Distributions made to the employee (other than distributions described in subparagraph (A), (C), or (D)) to the extent such distributions do not exceed the amount allowable as a deduction under section 213 to the employee for amounts paid during the taxable year for medical care (determined without regard to whether the employee itemizes deductions for such taxable year).

72(t)(2)(C) Payments to alternate payees pursuant to qualified domestic relations orders.--Any distribution to an alternate payee pursuant to a qualified domestic relations order (within the meaning of section 414(p)(1)).

72(t)(2)(D) Distributions to unemployed individuals for health insurance premiums.--

72(t)(2)(D)(i) In general.--Distributions from an individual retirement plan to an individual after separation from employment--

72(t)(2)(D)(i)(I) if such individual has received unemployment compensation for 12 consecutive weeks under any Federal or State unemployment compensation law by reason of such separation,

72(t)(2)(D)(i)(II) if such distributions are made during any taxable year during which such unemployment compensation is paid or the succeeding taxable year, and

72(t)(2)(D)(i)(III) to the extent such distributions do not exceed the amount paid during the taxable year for insurance described in section 213(d)(1)(D) with respect to the individual and the individual's spouse and dependents (as defined in section 152).

72(t)(2)(D)(ii) Distributions after reemployment.--Clause (i) shall not apply to any distribution made after the individual has been employed for at least 60 days after the separation from employment to which clause (i) applies.

72(t)(2)(D)(iii) Self-employed individuals.--To the extent provided in regulations, a self-employed individual shall be treated as meeting the requirements of clause (i)(I) if, under Federal or State law, the individual would have received unemployment compensation but for the fact the individual was self-employed.

72(t)(3)(A) Certain exceptions not to apply to individual retirement plans.--Subparagraphs (A)(v), (B), and (C) of paragraph (2) shall not apply to distributions from an individual retirement plan.

72(t)(3)(A) Certain exceptions not to apply to individual retirement plans.--Subparagraphs (A)(v), and (C) of paragraph (2) shall not apply to distributions from an individual retirement plan.

72(t)(3)(B) Periodic payments under qualified plans must begin after separation.--Paragraph (2)(A)(iv) shall not apply to any amount paid from a trust described in section 401(a) which is exempt from tax under section 501(a) or from a contract described in section 72(e)(5)(D)(ii) unless the series of payments begins after the employee separates from service.

72(t)(4)(A)(i) paragraph (1) does not apply to a distribution by reason of paragraph (2)(A)(iv), and

72(t)(4)(A)(ii) the series of payments under such paragraph are subsequently modified (other than by reason of death or disability)--

72(t)(4)(A)(ii)(I) before the close of the 5-year period beginning with the date of the first payment and after the employee attains age 591/2, or

the taxpayer's tax for the 1st taxable year in which such modification occurs shall be increased by an amount, determined under regulations, equal to the tax which (but for paragraph (2)(A)(iv)) would have been imposed, plus interest for the deferral period.

72(t)(4)(B) Deferral period.--For purposes of this paragraph, the term “deferral period” means the period beginning with the taxable year in which (without regard to paragraph (2)(A)(iv)) the distribution would have been includible in gross income and ending with the taxable year in which the modification described in subparagraph (A) occurs.

72(t)(5) Employee.--For purposes of this subsection, the term “employee” includes any participant, and in the case of an individual retirement plan, the individual for whose benefit such plan was established.

72(t)(6) Special rules for simple retirement accounts.--In the case of any amount received from a simple retirement account (within the meaning of section 408(p)) during the 2-year period beginning on the date such individual first participated in any qualified salary reduction arrangement maintained by the individual's employer under section 408(p)(2), paragraph (1) shall be applied by substituting “25 percent” for “10 percent”.

Sec. 414 DEFINITIONS AND SPECIAL RULES Subsec. (p) Qualified Domestic Relations Order Defined.--

414(p)(1)(A) Qualified domestic relations order.--The term “qualified domestic relations order” means a domestic relations order--

414(p)(1)(A)(i) which creates or recognizes the existence of an alternate payee's right to, or assigns to an alternate payee the right to, receive all or a portion of the benefits payable with respect to a participant under a plan, and

414(p)(1)(A)(ii) with respect to which the requirements of paragraphs (2) and (3) are met.

414(p)(1)(B) Domestic relations order.--The term “domestic relations order” means any judgment, decree, or order (including approval of a property settlement agreement) which--

414(p)(1)(B)(i) relates to the provision of child support, alimony payments, or marital property rights to a spouse, former spouse, child, or other dependent of a participant, and

414(p)(1)(B)(ii) is made pursuant to a State domestic relations law (including a community property law).

414(p)(2) Order must clearly specify certain facts.--A domestic relations order meets the requirements of this paragraph only if such order clearly specifies--

414(p)(2)(A) 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,

414(p)(2)(B) the amount or percentage of the participant's benefits to be paid by the plan to each such alternate payee, or the manner in which such amount or percentage is to be determined,

414(p)(3) Order may not alter amount, form, etc., of benefits.--A domestic relations order meets the requirements of this paragraph only if such order--

414(p)(3)(A) does not require a plan to provide any type or form of benefit, or any option, not otherwise provided under the plan,

414(p)(3)(B) does not require the plan to provide increased benefits (determined on the basis of actuarial value), and

414(p)(3)(C) does not require the payment of benefits to an alternate payee which are required to be paid to another alternate payee under another order previously determined to be a qualified domestic relations order.

414(p)(4)(A) In general.--A domestic relations order shall not be treated as failing to meet the requirements of subparagraph (A) of paragraph (3) solely because such order requires that payment of benefits be made to an alternate payee--

414(p)(4)(A)(i) in the case of any payment before a participant has separated from service, on or after the date on which the participant attains (or would have attained) the earliest retirement age,

414(p)(4)(A)(ii) as if the participant had retired on the date on which such payment is to begin under such order (but taking into account only the present value of the benefits actually accrued and not taking into account the present value of any employer subsidy for early retirement), and

414(p)(4)(A)(iii) in any form in which such benefits may be paid under the plan to the participant (other than in the form of a joint and survivor annuity with respect to the alternate payee and his or her subsequent spouse).

For purposes of clause (ii), the interest rate assumption used in determining the present value shall be the interest rate specified in the plan or, if no rate is specified, 5 percent.

414(p)(4)(B) Earliest retirement age.--Purposes of this paragraph, the term “earliest retirement age” means the earlier of--

414(p)(4)(B)(i) the date on which the participant is entitled to a distribution under the plan, or

414(p)(4)(B)(ii)(II) the earliest date on which the participant could begin receiving benefits under the plan if the participant separated from service.

414(p)(5) Treatment of former spouse as surviving spouse for purposes of determining survivor benefits.--To the extent provided in any qualified domestic relations order--

414(p)(5)(A) the former spouse of a participant shall be treated as a surviving spouse of such participant for purposes of sections 401(a)(11) and 417 (and any spouse of the participant shall not be treated as a spouse of the participant for such purposes), and

414(p)(5)(B) if married for at least 1 year, the surviving former spouse shall be treated as meeting the requirements of section 417(d).

414(p)(6)(A) Notice and determination by administrator.--In the case of any domestic relations order received by a plan--

414(p)(6)(A)(i) the plan administrator shall promptly notify the participant and each alternate payee of the receipt of such order and the plan's procedures for determining the qualified status of domestic relations orders, and

414(p)(6)(A)(ii) within a reasonable period after receipt of such order, the plan administrator shall determine whether such order is a qualified domestic relations order and notify the participant and each alternate payee of such determination.

414(p)(6)(B) Plan to establish reasonable procedures.--Each plan shall establish reasonable procedures to determine the qualified status of domestic relations orders and to administer distributions under such qualified orders.

414(p)(7)(A) In general.--During any period in which the issue of whether a domestic relations order is a qualified domestic relations order is being determined (by the plan administrator, by a court of competent jurisdiction, or otherwise), the plan administrator shall separately account for the amounts (hereinafter in this paragraph referred to as the “segregated amounts”) which would have been payable to the alternate payee during such period if the order had been determined to be a qualified domestic relations order.

414(p)(7)(B) Payment to alternate payee if order determined to be qualified domestic relations order.--If within the 18-month period described in subparagraph (E) the order (or modification thereof) is determined to be a qualified domestic relations order, the plan administrator shall pay the segregated amounts (including any interest thereon) to the person or persons entitled thereto.

414(p)(7)(C) Payment to plan participant in certain cases.--If within the 18-month period described in subparagraph (E)--

414(p)(7)(C)(i) it is determined that the order is not a qualified domestic relations order, or

414(p)(7)(C)(ii) the issue as to whether such order is a qualified domestic relations order is not resolved, then the plan administrator shall pay the segregated amounts (including any interest thereon) to the person or persons who would have been entitled to such amounts if there had been no order.

414(p)(7)(D) Subsequent determination or order to be applied prospectively only.--Any determination that an order is a qualified domestic relations order which is made after the close of the 18-month period described in subparagraph (E) shall be applied prospectively only.

414(p)(7)(E) Determination of 18-month period.--For purposes of this paragraph, the 18-month period described in this subparagraph is the 18-month period beginning with the date on which the first payment would be required to be made under the domestic relations order.

414(p)(8) Alternate payee defined.--The term “alternate payee” means any spouse, former spouse, child or other dependent of a participant who is recognized by a domestic relations order as having a right to receive all, or a portion of, the benefits payable under a plan with respect to such participant.

414(p)(9) Subsection not to apply to plans to which section 401(a)(13) does not apply.--This subsection shall not apply to any plan to which section 401(a)(13) does not apply. For purposes of this title, except as provided in regulations, any distribution from an annuity contract under section 403(b) pursuant to a qualified domestic relations order shall be treated in the same manner as a distribution from a plan to which section 401(a)(13) applies.

414(p)(10) Waiver of certain distribution requirements.--With respect to the requirements of subsections (a) and (k) of section 401, section 403(b), and section 409(d), plan shall not be treated as failing to meet such requirements solely by reason of payments to an alternative payee pursuant to a qualified domestic relations order.

414(p)(11) Application of rules to governmental and church plans.--For purposes of this title, a distribution or payment from a governmental plan (as defined in subsection (d)) or a church plan (as described in subsection (e)) shall be treated as made pursuant to a qualified domestic relations order if it is made pursuant to a domestic relations order which meets the requirement of clause (i) of paragraph (1)(A).

414(p)(12) Consultation with the secretary.--In prescribing regulations under this subsection and section 401(a)(13), the Secretary of Labor shall consult with the Secretary.

Practice Suggestions To Advisers And Professionals

1. If any retirement type settlements are involved a QDRO should be included as a part of the divorce decree. The professional should consult current authorities and citations as the law is constantly changing.

{Last date letter read} 06/05/97 Last Read By: Bob Parrish Last Date Saved: 06/05/97 9:29 PM Last Saved By: Bob Parrish

[i] 97FED ¶47,848(M) Jerry L. Burton v. Commissioner CCH Dec. 51,822(M), Dkt. 6115-95, January 13, 1997

T.C. Memo. 1997-20, opinion by Judge Nims.[Appealable, barring stipulation to the contrary, to CA-5.--CCH.]

[Code Secs. 401 and 414 ]

Qualified domestic relations orders: Qualification as.--An individual was liable for tax on an entire lump-sum distribution from a qualified pension plan because amounts used to satisfy his mortgage obligation and to pay his ex-wife pursuant to the terms of their divorce decree were not excludable as payments made pursuant to a qualified domestic relations order (QDRO). The divorce decree was rendered after the lump-sum distribution was made. Therefore, the distribution was not made by the plan administrator to an alternate payee in response to the divorce decree, and the decree did not qualify as a QDRO. BACK REFERENCES: 97FED ¶17,733.60 and 97FED ¶19,171E.01.

[Code Sec. 72 ]

Retirement plans: Early distributions: 10% tax.--The entire lump-sum distribution from a qualified pension plan to an individual upon his termination of employment was taxable to him because no amounts were excludable as payments made pursuant to a qualified domestic relations order. Therefore, the entire distribution was subject to the 10% tax on early distributions from a qualified retirement plan. BACK REFERENCES: 97FED ¶6140.765 and 97FED ¶6140.775.

[ii] Sample Language For Spouse's Rights To Survivor Annuities and QDROs

l Notice 97-10, Notice 97-11 l

As required by the Small Business Job Protection Act of 1996, the IRS has provided sample language (1) to assist plan administrators in preparing spousal consent forms to waive certain annuity benefits (Notice 97-10) and (2) to assist domestic relations attorneys in drafting a qualified domestic relations order (QDRO) (Notice 97-11).

Waiver of annuity benefits. The new sample language makes it easier for spouses of plan participants to understand their rights to survivor annuities under qualified plans as required under IRC §417(a)(3). The sample language can be included in a form used for a spouse consent to a participant's waiver of a qualified joint and survivor annuity (QJSA) or, in the case of a participant who dies before the annuity starting date, a qualified preretirement survivor annuity (QPSA), or to a participant's choice of a non-spouse beneficiary in a defined contribution plan not subject to the QJSA and QPSA requirements. The sample language is optional.

QDROs. In addition to the sample QDRO language, the IRS has provided instructions intended to assist domestic relations attorneys, plan participants, spouses and former spouses of participants, and plan administrators in drafting and reviewing a QDRO.

References: 97FED ¶46,222, ¶46,223; CFTS §C:4.144; §C:14.105.

Notice 97-11:

Cumulative Bulletin Notice 97-11Notice 97-11, , I.R.B. 1997-2, 50

[Code Sec. 414 ]

Qualified domestic relations order: Drafting and reviewing: Sample language.--The IRS has provided information to assist domestic relations attorneys, plan participants, spouses and former spouses of participants, and plan administrators in drafting and reviewing a qualified domestic relations order (QDRO). Also, the notice provides sample language that may be included in a QDRO relating to a plan that is qualified under Code Sec. 401(a) or 403(a) and that is subject to Code Sec. 401(a)(13). BACK REFERENCE: 97FED ¶19,171E.01.

I. PURPOSE

This Notice provides information intended to assist domestic relations attorneys, plan participants, spouses and former spouses of participants, and plan administrators in drafting and reviewing a qualified domestic relations order (“QDRO”). The Notice provides sample language that may be included in a QDRO relating to a plan that is qualified under §401(a) or §403(a) of the Internal Revenue Code of 1986 (“qualified plan” or “plan”) and that is subject to §401(a)(13). The Notice also discusses a number of issues that should be considered in drafting a QDRO. A QDRO is a domestic relations order that provides for payment of benefits from a qualified plan to a spouse, former spouse, child or other dependent of a plan participant and that meets certain requirements.

A. Statutory QDRO Requirements

Section 401(a)(13)(A) of the Code provides that benefits under a qualified plan may not be assigned or alienated. Section 401(a)(13)(B) establishes an exception to the antialienation rule for assignments made pursuant to domestic relations orders that constitute QDROs within the meaning of §414(p). A “domestic relations order” is defined in §414(p)(1)(B) as any judgment, decree, or order (including approval of a property settlement agreement) that (i) relates to the provision of child support, alimony payments, or marital property rights to a spouse, former spouse, child, or other dependent of a participant, and (ii) is made pursuant to a State domestic relations law (including a community property law). There is no exception to the §401(a)(13)(A) antialienation rule for assignments made pursuant to domestic relations orders that are not QDROs.

Section 414(p)(1)(A) provides, in general, that a QDRO is a domestic relations order that creates or recognizes the existence of an alternate payee's right, or assigns to an alternate payee the right, to receive all or a portion of the benefits payable with respect to a participant under a plan, and that meets the requirements of paragraphs (2) and (3) of §414(p). Section 414(p)(2) requires that a QDRO clearly specify: (A) the name and last known mailing address (if any) of the participant and of each alternate payee covered by the order, (B) the amount or percentage of the participant's benefits to be paid by the plan to each alternate payee, or the manner in which that amount or percentage is to be determined, (C) the number of payments or period to which the order applies, and (D) each plan to which the order applies.

Section 414(p)(3) provides that a QDRO cannot require a plan to provide any type or form of benefit, or any option, not otherwise provided under the plan; cannot require a plan to provide increased benefits (determined on the basis of actuarial value); and cannot require the payment of benefits to an alternate payee that are required to be paid to another alternate payee under another order previously determined to be a QDRO. Section 414(p)(4)(A)(i) provides that a domestic relations order shall not be treated as failing to meet the requirements of §414(p)(3)(A) (and thus will not fail to be a QDRO) solely because the order requires payment of benefits to an alternate payee on or after the participant's earliest retirement age, even if the participant has not separated from service at that time. Section 414(p)(4)(B) defines earliest retirement age as the earlier of (i) the date on which the participant is entitled to a distribution under the plan, or (ii) the later of (I) the date the participant attains age 50, or (II) the earliest date on which the participant could begin receiving benefits under the plan if the participant separated from service.

Section 414(p)(5) permits a QDRO to provide that the participant's former spouse shall be treated as the participant's surviving spouse for purposes of §§401(a)(11) and 417 (relating to the right to receive survivor benefits and requirements concerning consent to distributions), and that any other spouse of the participant shall not be treated as a spouse of the participant for these purposes. An alternate payee is defined under §414(p)(8) as any spouse, former spouse, child or other dependent of a participant who is recognized by a domestic relations order as having a right to receive all, or a portion of, the benefits payable under a plan with respect to the participant. Section 414(p)(10) provides that a plan shall not fail to satisfy the requirements of §401(a), 401(k) or 403(b) solely by reason of payments made to an alternate payee pursuant to a QDRO.

B. Small Business Job Protection Act of 1996

Section 1457(a)(2) of the Small Business Job Protection Act of 1996 (“SBJPA”) directs the Secretary of the Treasury (“Secretary”) to develop sample language for inclusion in a form for a QDRO described in §414(p)(1)(A) of the Code and §206(d)(3)(B)(i) of the Employee Retirement Income Security Act of 1974 (“ERISA”) that meets the requirements contained in those sections, and the provisions of which focus attention on the need to consider the treatment of any lump sum payment, qualified joint and survivor annuity (“QJSA”), or qualified preretirement survivor annuity (“QPSA”). Accordingly, the Service and Treasury are publishing the discussion and sample QDRO language set forth in the Appendix to this Notice.

Section 1457(a)(1) of the SBJPA directs the Secretary to publish sample language that can be included in a form that is used for a spouse to consent to a participant's waiver of a QJSA or QPSA. This sample language for use in spousal consent forms is contained in Notice 97-10 in this Bulletin.

C. Department of Labor Interpretive Authority

Section 206(d)(3) of ERISA (29 U.S.C. §1056(d)(3)) contains QDRO provisions that are substantially parallel to those of §414(p) of the Code. The Department of Labor has jurisdiction to interpret these provisions (except to the extent provided in §401(n) of the Code) and the provisions governing the fiduciary duties owed with respect to domestic relations orders and QDROs. Section 401(n) gives the Secretary of the Treasury the authority to prescribe rules or regulations necessary to coordinate the requirements of §§401(a)(13) and 414(p), and the regulations issued by the Department of Labor thereunder, with other Code provisions. The Department of Labor has reviewed this Notice, including its Appendix, and has advised the Service and Treasury that the discussion and sample language are consistent with the views of the Department of Labor concerning the statutory requirements for QDROs. This Notice, including its Appendix, is not intended by the Service or Treasury to convey interpretations of the statutory requirements applicable to QDROs, but only to provide examples of language that may be (but are not required to be) used in drafting a QDRO that satisfies these requirements.

II. SAMPLE LANGUAGE

The Appendix to this Notice has two parts. Part I discusses certain issues that should be considered when drafting a QDRO. Part II contains sample language that will assist in drafting a QDRO. Drafters who use the sample language will need to conform it to the terms of the retirement plan to which the QDRO applies, and to specify the amounts assigned and other terms of the QDRO so as to achieve an appropriate division of marital property or level of family support. A domestic relations order is not required to incorporate the sample language in order to satisfy the requirements for a QDRO, and a domestic relations order that incorporates part of the sample language may omit or modify other parts.

The sample language addresses a variety of matters, but is not designed to address all retirement benefit issues that may arise in each domestic relations matter or QDRO. Further, some of the sample language, while helpful in facilitating the administration of a QDRO, is not necessarily required for the order to satisfy the requirements for a QDRO. Alternative formulations would be permissible for use in drafting orders that meet the statutory requirements for a QDRO.

III. OTHER SOURCES OF INFORMATION

The Pension Benefit Guaranty Corporation (“PBGC”) recently published a booklet entitled “Divorce Orders & PBGC,” which discusses the special QDRO rules that apply for plans that have been terminated and are trusteed by PBGC, and provides model QDROs for use with those plans. This publication may be obtained by calling PBGC's Customer Service Center at 1-800-400-PBGC or electronically via the PBGC internet site at “http://www.pbgc.gov”.

Additional information on the rights of participants and spouses to plan benefits can be found in a two-booklet set published by the Service, entitled “Looking Out for #2.” These booklets discuss retirement benefit choices under a defined contribution or a defined benefit plan, and may be obtained by calling the Internal Revenue Service at 1-800-TAX-FORM, and asking for Publication 1565 (defined contribution plans) or Publication 1566 (defined benefit plans).

IV. COMMENTS

The Service invites the public to comment on the QDRO discussion and sample language included in the Appendix to this Notice, and welcomes suggestions concerning possible additional sample language. Comments may be submitted to the Internal Revenue Service at CC:DOM:CORP:R (Notice 97-11), Room 5226, Internal Revenue Service, POB 7604, Ben Franklin Station, Washington, D.C. 20044. Alternatively, taxpayers may hand-deliver comments between the hours of 8 a.m. and 5 p.m. to CC:DOM:CORP:R (Notice 97-11), Courier's desk, Internal Revenue Service, 1111 Constitution Ave., N.W., Washington, D.C., or may submit comments electronically via the IRS internet site at “http://www.irs.ustreas.gov/prod/tax†regs/comments.html”.

DRAFTING INFORMATION

The principal authors of this Notice are Diane S. Bloom of the Employee Plans Division and Susan M. Lennon of the Office of the Associate Chief Counsel (Employee Benefits and Exempt Organizations); however, other personnel from the Service and Treasury contributed to its development. For further information regarding this Notice, please contact the Employee Plans Division's taxpayer assistance telephone service at (202) 622-6074/6075, between the hours of 1:30 p.m. and 4 p.m. Eastern Time, Monday through Thursday. Alternatively, please call Ms. Bloom at (202) 622-6214 or Ms. Lennon at (202) 622-4606. Questions concerning QDROs may be addressed to Susan G. Lahne of the Pension and Welfare Benefits Administration, Department of Labor, at (202) 219-7461. These telephone numbers are not toll-free.

APPENDIX

Part I of this Appendix discusses certain issues that are relevant in drafting a qualified domestic relations order (“QDRO”). Part II of this Appendix contains sample language that can be used in a QDRO. However, the discussion and sample language do not attempt to address every issue that may arise in drafting a QDRO. Also, some parts of the discussion are not relevant to all situations and some parts of the sample language are not appropriate for all QDROs. In formulating a particular QDRO, it is important that the drafters tailor the QDRO to the needs of the parties and ensure that the QDRO is consistent with the terms of the retirement plan to which the QDRO applies.

PART I. DISCUSSION OF QDRO REQUIREMENTS AND RELATED ISSUES

In order to be recognized as a QDRO, an order must first be a “domestic relations order.” A domestic relations order is any judgment, decree or order (including approval of a property settlement) which (i) relates to the provision of child support, alimony payments or marital property rights to a spouse, former spouse, child or other dependent of the plan participant, and (ii) is made pursuant to a State domestic relations law (including a community property law). A State authority must actually issue an order or formally approve a proposed property settlement before it can be a domestic relations order. A property settlement signed by a participant and the participant's former spouse or a draft order to which both parties consent is not a domestic relations order until the State authority has adopted it as an order or formally approved it and made it part of the domestic relations proceeding.

The sample language in Part II assumes that the QDRO applies to one qualified plan and one alternate payee. If a QDRO is intended to cover more than one qualified plan or alternate payee, the QDRO should clearly state which qualified plan and which alternate payee each provision is intended to address.

The terms of a qualified plan must be set forth in a written document. The plan must also establish written QDRO procedures to be used by the plan administrator in determining whether a domestic relations order is a QDRO and in administering QDROs. The plan administrator maintains copies of the plan document and the plan's QDRO procedures. If the plan is required under federal law to have a summary plan description, or “SPD,” the plan administrator will also have a copy of the SPD. The information in these documents is helpful in drafting a QDRO. The drafter of a QDRO may wish to obtain copies of these documents before drafting a QDRO.

A. IDENTIFICATION OF PARTICIPANT AND ALTERNATE PAYEE

A QDRO must clearly specify the name and last known mailing address (if any) of the participant and of each alternate payee covered by the QDRO. In the event that an alternate payee is a minor or legally incompetent, the QDRO should also include the name and address of the alternate payee's legal representative. A QDRO can have more than one alternate payee, such as a former spouse and a child.

The “participant” is the individual whose benefits under the plan are being divided by the QDRO. The participant's spouse (or former spouse, child, or other dependent) who receives some or all of the plan's benefits with respect to the participant under the terms of the QDRO is the “alternate payee.”

B. IDENTIFICATION OF RETIREMENT PLAN

A QDRO must clearly identify each plan to which the QDRO applies. A QDRO can satisfy this requirement by stating the full name of the plan as provided in the plan document.

C. AMOUNT OF BENEFITS TO BE PAID TO ALTERNATE PAYEE

A QDRO must clearly specify the amount or percentage of the participant's benefits in the plan that is assigned to each alternate payee, or the manner in which the amount or percentage is to be determined. Many factors should be taken into account in determining which benefits to assign to an alternate payee and how these benefits are to be assigned. The following discussion highlights some of these factors. Because of the complexity and variety of the factors that should be considered, and the need to tailor the assignment of benefits under a QDRO to the individual circumstances of the parties, specific sample language regarding the assignment of benefits has not been provided in Part II of this Appendix.

1. Types of Benefits

In order to decide how to divide benefits under a QDRO, the drafter first should determine the types of benefits the plan provides. Most benefits provided by qualified plans can be classified as (1) retirement benefits that are paid during the participant's life and (2) survivor benefits that are paid to beneficiaries after the participant's death. Generally, a QDRO can assign all or a portion of each of these types of benefits to an alternate payee. The drafters of a QDRO should coordinate the assignment of these types of benefits. QDRO drafters should also consider how the benefits divided under the QDRO may be affected, under the plan, by the death of either the participant or the alternate payee.

2. Types of Qualified Plans

Another important factor to consider in the drafting of a QDRO is the type of plan to which the QDRO will apply. As discussed below, the type of plan may affect the types of benefits available for assignment, how the parties choose to assign the benefits, and other matters.

There are two basic types of qualified plans to which QDROs apply: defined benefit plans and defined contribution plans.

a. Defined Benefit Plans

A “defined benefit plan” promises to pay each participant a specific benefit at retirement. The basic retirement benefits are usually based on a formula that takes into account factors such as the number of years a participant has worked for the employer and the participant's salary. The basic retirement benefits are generally expressed in the form of periodic payments for the participant's life beginning at the plan's normal retirement age. This stream of periodic payments is generally known as an “annuity.” There are special rules that apply if the participant is married; these rules are discussed in greater detail in section E below. A plan may also provide that these retirement benefits may be paid in other forms, such as a lump sum payment.

b. Defined Contribution Plans

A “defined contribution plan” is a retirement plan that provides for an individual account for each participant. The participant's benefits are based solely on the amount contributed to the participant's account, and any income, expenses, gains and losses, and any forfeitures of accounts of other participants which may be allocated to such participant's account. Examples of defined contribution plans include a profit sharing plan (including a “401(k)” plan), an employee stock ownership plan (an “ESOP”) and a money purchase pension plan. Defined contribution plans commonly permit retirement benefits to be paid in the form of a lump sum payment of the participant's entire account balance.

3. Approaches to Dividing Retirement Benefits

There are two common approaches to dividing retirement benefits in a QDRO: one awards a separate interest in the retirement benefits to the alternate payee, and the other allows the alternate payee to share in the payment of the retirement benefits. In drafting a QDRO using either of these approaches, consideration should be given to factors such as whether the plan is a defined benefit plan or defined contribution plan, and the purpose of the QDRO (such as whether the QDRO is meant to provide spousal support or child support, or to divide marital property).

a. Separate Interest Approach

A QDRO that creates a “separate interest” divides the participant's benefits into two separate parts: one for the participant and one for the alternate payee. Subject to the terms of the plan and as discussed in more detail below, a QDRO may provide that the alternate payee can determine the form in which his or her benefits are paid and when benefit payments commence. If benefits are allocated under the separate interest approach, the drafters of a QDRO should take into account certain issues depending on the type of plan.

(1) Issues Relevant to Defined Benefit Plans

The treatment of subsidies provided by a plan and the treatment of future increases in benefits due to increases in the participant's compensation, additional years of service, or changes in the plan's provisions are among the matters that should be considered when drafting a QDRO that uses the separate interest approach to allocate benefits under a defined benefit plan.

Subsidies. Defined benefit plans may promise to pay benefits at various times and in alternative forms. Benefits paid at certain times or in certain forms may have a greater actuarial value than the basic retirement benefits payable at normal retirement age. When one form of benefit has a greater actuarial value than another form, the difference in value is often called a subsidy. Plans usually provide that a participant must meet specific eligibility requirements, such as working for a minimum number of years for the employer that maintains the plan, in order to receive the subsidy.

For example, a defined benefit plan may offer an “early retirement subsidy” to employees who retire before the plan's normal retirement age but after having worked for a specific number of years for the employer maintaining the plan. In some cases, this subsidized benefit provides payments in the form of an annuity that pays the same annual amount as would be paid if the payments commenced instead at the normal retirement age. Because these benefits are not reduced for early commencement, they have a greater actuarial value than benefits payable at normal retirement age. This subsidy may be available only for certain forms of benefit.

A QDRO may award to the alternate payee all or part of the participant's basic retirement benefits. A QDRO can also address the disposition of any subsidy to which the participant may become entitled after the QDRO has been entered.

Future Increases in the Participant's Benefits. A participant's basic retirement benefits may increase due to circumstances that occur after a QDRO has been entered, such as increases in salary, crediting of additional years of service, or amendments to the plan's provisions, including amendments to provide cost of living adjustments. The treatment of such benefit increases should be considered when drafting a QDRO using the separate interest approach.

(2) Issues Relevant to Defined Contribution Plans

Investment of the amount assigned to the alternate payee when the account is invested in more than one investment vehicle and division of any future allocation of contributions or forfeitures to the participant's account are among the matters that should be considered when drafting a QDRO that allocates the alternate payee a separate interest under a defined contribution plan.

Investment Choices. The participant's account may be invested in more than one investment fund. If the plan provides for participant-directed investment of the participant's account, consideration should be given to how the alternate payee's interest will be invested.

Future Allocations. A participant's account balance may later increase due to the allocation of contributions or forfeitures after the QDRO has been entered. A QDRO may provide that the amounts assigned to the alternate payee will include a portion of such future allocations.

b. Shared Payment Approach

A QDRO may use the “shared payment” approach, under which benefit payments from the plan are split between the participant and the alternate payee. The alternate payee receives payments under this approach only when the participant receives payments. A QDRO may provide that the alternate payee will commence receiving benefit payments when the participant begins receiving payments or at a later stated date, and that the alternate payee will cease to share in the benefit payments at a stated date (or upon a stated event, provided that adequate notice is given to the plan). In splitting the benefit payments, the QDRO may award the alternate payee either a percentage or a dollar amount of each of the participant's benefit payments; in either case, the amount awarded cannot exceed the amount of each payment to which the participant is entitled under the plan. If a QDRO awards a percentage of the participant's benefit payments (rather than a dollar amount), then, unless the QDRO provides otherwise, the alternate payee generally will automatically receive a share of any future subsidy or other increase in the participant's benefits.

D. FORM AND COMMENCEMENT OF PAYMENT TO ALTERNATE PAYEE

QDRO drafters should take into account certain issues that may arise in connection with the alternate payee's choice of a form of benefit payments and the date on which payment will commence.

1. Separate Interest Approach

a. Form of Alternate Payee's Benefit Payments

A QDRO either may specify a particular form in which payments are to be made to the alternate payee or may provide that the alternate payee may choose a form of benefit from among the options available to the participant. However, federal law provides that the alternate payee cannot receive payments in the form of a joint and survivor annuity with respect to the alternate payee and his or her subsequent spouse.

The choice of the form of benefits should take into account the period over which payments will be made. For example, if the alternate payee elects to receive a lump sum payment, no further payments will be made by the plan with respect to the alternate payee's interest.

Any decision concerning the form of benefit should take into account the difference, if any, in the actuarial value of different benefit forms available under the plan. For example, as discussed above, a plan might provide an early retirement subsidy that is available only for payment in certain forms.

In addition, the forms of benefit available to the alternate payee may be limited by §401(a)(9) of the Code, which specifies the date by which benefit payments from a qualified plan must commence and limits the period over which the benefit payments may be made. Section 1.401(a)(9)-1, Q&A H-4, of the Proposed Income Tax Regulations addresses the application of the required minimum distribution rules of §401(a)(9) to payments to an alternate payee. The proposed regulation limits the period over which benefits may be paid with respect to the alternate payee's interest. For example, the proposed regulation provides that distribution of the alternate payee's separate interest will not satisfy §401(a)(9)(A)(ii) of the Code if the separate interest is distributed over the joint lives of the alternate payee and a designated beneficiary (other than the participant).

b. Commencement of Benefit Payments to Alternate Payee

Under the separate interest approach, the alternate payee may begin receiving benefits at a different time than the participant. A QDRO either may specify a time at which payments are to commence to the alternate payee or may provide that the alternate payee can elect a time when benefits will commence in accordance with the terms of the plan. In two circumstances, an alternate payee who is given a separate interest may begin receiving his or her separate benefit before the participant is eligible to begin receiving payments. First, federal law provides that benefit payments to the alternate payee may begin as soon as the participant attains his or her earliest retirement age. Federal law defines “earliest retirement age” as the earlier of (i) the date on which the participant is entitled to a distribution under the plan, or (ii) the later of (I) the date the participant attains age 50, or (II) the earliest date on which the participant could begin receiving benefits under the plan if the participant separated from service. Second, the retirement plan may (but is not required to) allow payments to begin to an alternate payee at a date before the earliest retirement date.

2. Shared Payment Approach

As indicated above, under the shared payment approach, benefit payments are split between the participant and the alternate payee. The alternate payee receives payments in the same form as the participant. Further, payments to the alternate payee do not commence before the participant has begun to receive benefits. Payments to the alternate payee can cease at any time stated in the QDRO but do not continue after payments with respect to the participant cease. As noted above, a QDRO must state the number of payments or the period to which the order applies.

E. SURVIVOR BENEFITS AND TREATMENT OF FORMER SPOUSE AS PARTICIPANT'S SPOUSE

Survivor benefits include both benefits payable to surviving spouses and other benefits that are payable after the participant's death. These benefits can be awarded to an alternate payee. In determining the assignment of survivor benefits, QDRO drafters should take into account that benefits awarded to the alternate payee under a QDRO will not be available to a subsequent spouse of the participant or to another beneficiary. QDRO drafters may consult with the plan administrator for information on the survivor benefits provided under the plan.

A QDRO may provide for treatment of a former spouse of a participant as the participant's spouse with respect to all or a portion of the spousal survivor benefits that must be provided under federal law. The following discussion explains the spousal survivor benefits that must be offered under a plan, and identifies issues that should be considered in determining whether to treat the alternate payee as the participant's spouse.

Only a spouse or former spouse of the participant can be treated as a spouse under a QDRO. A child or other dependent who is an alternate payee under a QDRO cannot be treated as the spouse of a participant.

Retirement plans generally need not provide the special survivor benefits to the participant's surviving spouse unless the participant is married for at least one year. If the retirement plan to which the QDRO relates contains such a one-year marriage requirement, then the QDRO cannot require that the alternate payee be treated as the participant's spouse if the marriage lasted for less than one year.

1. Qualified Joint and Survivor Annuity

Federal law generally requires that defined benefit plans and certain defined contribution plans pay retirement benefits to participants who were married on the participant's annuity starting date (this is the first day of the first period for which an amount is payable to the participant) in a special form called a qualified joint and survivor annuity, or QJSA. Under a QJSA, retirement payments are made monthly (or at other regular intervals) to the participant for his or her lifetime; after the participant dies, the plan pays the participant's surviving spouse an amount each month (or other regular interval) that is at least one half of the retirement benefit that was paid to the participant. At any time that benefits are permitted to commence under the plan, a QJSA must be offered that commences at the same time and that has an actuarial value that is at least as great as any other form of benefit payable under the plan at the same time. A married participant can choose to receive retirement benefits in a form other than a QJSA if the participant's spouse agrees in writing to that choice.

2. Qualified Preretirement Survivor Annuity

Federal law generally requires that defined benefit plans and certain defined contribution plans pay a monthly survivor benefit to a surviving spouse for the spouse's life when a married participant dies prior to the participant's annuity starting date, to the extent the participant's benefit is nonforfeitable under the terms of the plan at the time of his or her death. This benefit is called a qualified preretirement survivor annuity, or QPSA. As a general rule, an individual loses the right to the QPSA survivor benefits when he or she is divorced from the participant. However, if a former spouse is treated as the participant's surviving spouse under a QDRO, the former spouse is eligible to receive the QPSA unless the former spouse consents to the waiver of the QPSA. If the spouse does not waive the QPSA, the plan may allow the spouse to receive the value of the QPSA in a form other than an annuity.

3. Defined Contribution Plans Not Subject to the QJSA or QPSA Requirements

Those defined contribution plans that are not required to pay benefits to married participants in the form of a QJSA or a QPSA are required by federal law to pay the balance remaining in the participant's account after the participant dies to the participant's surviving spouse. If the spouse gives written consent, the participant can direct that upon his or her death the account will be paid to a beneficiary other than the spouse, for example, the couple's children.

4. Alternate Payee Treated as Spouse

A QDRO may provide that an alternate payee who is a former spouse of the participant will be treated as the participant's spouse for some or all of the benefits payable upon the participant's death, so that the alternate payee will receive benefits provided to a spouse under the plan. To the extent that a former spouse is to be treated under the plan as the participant's spouse pursuant to a QDRO, any subsequent spouse of the participant cannot be treated as the participant's surviving spouse. Thus, QDRO drafters should consider the potential impact of designating a former spouse as the participant's spouse on the disposition of survivor benefits among the former spouse and any subsequent spouse of the participant, as well as the impact on children or any other beneficiaries designated by the participant in accordance with the terms of the plan.

In determining the portion of the participant's benefits for which the alternate payee is treated as the spouse, the drafters should take into account the manner in which benefits are otherwise divided under the QDRO. In particular, consideration should be given to whether the formula for dividing the participant's benefits for this purpose should be coordinated with the formula otherwise used for dividing the benefits.

Under a defined benefit plan, or a defined contribution plan that is subject to the QJSA and QPSA requirements, to the extent the former spouse is treated as the current spouse, the former spouse must consent to payment of retirement benefits in a form other than a QJSA or to the participant's waiver of the QPSA. For example, in a defined benefit plan, the participant would not be able to elect to receive a lump sum payment of the retirement benefits for which the alternate payee is treated as the participant's spouse unless the alternate payee consents. Similarly, the former spouse's consent might be required for any loan to the participant from the plan that is secured by his or her retirement benefits. In a defined contribution plan that is not subject to the QJSA and QPSA requirements, to the extent the QDRO treats the former spouse as the participant's spouse under the plan, the survivor benefits under the plan must be paid to the former spouse unless he or she consents to have those benefits paid to someone else.

F. TAX TREATMENT OF BENEFIT PAYMENTS MADE PURSUANT TO A QDRO

The federal income tax treatment of retirement benefits is governed by federal law, and a QDRO cannot designate who will be liable for the taxes owed when retirement benefits are paid. For a description of the tax consequences of payments to an alternate payee pursuant to a QDRO, see Internal Revenue Service Publication 575, “Pension and Annuity Income.” A local IRS office can provide this publication, or it may be obtained by calling 1-800-TAX-FORM.

PART II. SAMPLE LANGUAGE FOR INCLUSION IN QDRO

A. SAMPLE LANGUAGE FOR IDENTIFICATION OF PARTICIPANT AND ALTERNATE PAYEE

The “Participant” is [insert name of Participant]. The Participant's address is [insert Participant's address]. The Participant's social security number is [insert Participant's social security number].

The “Alternate Payee” is [insert name of Alternate Payee]. The Alternate Payee's address is [insert Alternate Payee's address]. The Alternate Payee's social security number is [insert Alternate Payee's social security number]. The Alternate Payee is the [describe the Alternate Payee's relationship to Participant] of the Participant.

B. SAMPLE LANGUAGE FOR IDENTIFICATION OF RETIREMENT PLAN

This order applies to benefits under the [insert formal name of retirement plan] (“Plan”).

C. AMOUNT OF BENEFITS TO BE PAID TO ALTERNATE PAYEE

Instruction: The QDRO should clearly specify the amount or percentage of benefits assigned to the Alternate Payee or the manner in which the amount or percentage is to be determined, and the number of payments or period to which the Order applies. There are many different forms in which benefits may be paid from a qualified plan. Because of the diversity of factors that should be considered, and the need to tailor the assignment of benefits under a QDRO to meet the needs of the parties involved, specific sample language regarding the assignment of benefits has not been provided. See the discussion in Part I for further information.

D. SAMPLE LANGUAGE FOR FORM AND COMMENCEMENT OF PAYMENT TO ALTERNATE PAYEE

Instruction: Drafters using the separate interest approach may use paragraph 1. Drafters using the shared payment approach may use paragraph 2. Drafters using the separate interest approach for a portion of the benefits allocated to the alternate payee and the shared payment approach for the remainder should modify the sample language to specify the benefits to which each paragraph provided below applies.

1. Separate Interest Approach

The Alternate Payee may elect to receive payment from the Plan of the benefits assigned to the Alternate Payee under this Order in any form in which such benefits may be paid under the Plan to the Participant (other than in the form of a joint and survivor annuity with respect to the Alternate Payee and his or her subsequent spouse), but only if the form elected complies with the minimum distribution requirements of §401(a)(9) of the Internal Revenue Code. Payments to the Alternate Payee pursuant to this Order shall commence on any date elected by the Alternate Payee (and such election shall be made in accordance with the terms of the Plan), but not earlier than the Participant's earliest retirement age (or such earlier date as allowed under the terms of the Plan), and not later than the earlier of (A) the date the Participant would be required to commence benefits under the terms of the Plan or (B) the latest date permitted by §401(a)(9) of the Internal Revenue Code. For purposes of this Order, the Participant's earliest retirement age shall be the earlier of (i) the date on which the participant is entitled to a distribution under the Plan, or (ii) the later of (I) the date the Participant attains age 50, or (II) the earliest date on which the Participant could begin receiving benefits under the plan if the Participant separated from service.

2. Shared Payment Approach

The Alternate Payee shall receive payments from the Plan of the benefits assigned to the Alternate Payee under this Order (including payments attributable to the period in which the issue of whether this Order is a qualified domestic relations order is being determined) commencing as soon as practicable after this Order has been determined to be a qualified domestic relations order or, if later, on the date the Participant commences receiving benefit payments from the Plan. Payment to the Alternate Payee shall cease on the earlier of: [insert date or future event, such as the Alternate Payee's remarriage], or the date that payments from the Plan with respect to the Participant cease.

E. SAMPLE LANGUAGE FOR TREATMENT OF FORMER SPOUSE AS PARTICIPANT'S SPOUSE

Instruction: The Alternate Payee may be treated as the Participant's spouse only if the Alternate Payee is the Participant's spouse or former spouse, and not if the Alternate Payee is a child or other dependent of the Participant. If the Alternate Payee is the Participant's spouse or former spouse, drafters may select sample paragraph 1, sample paragraph 2, or sample paragraph 3. Sample paragraph 1 applies if the Alternate Payee is treated as the Participant's spouse for all of the spousal survivor benefits payable with respect to the Participant's benefits under the Plan. Sample paragraph 2 applies if the Alternate Payee is treated as the Participant's spouse for a portion of the spousal survivor benefits payable with respect to the Participant's benefits under the Plan. Sample paragraph 3 applies if the Alternate Payee is not treated as the Participant's spouse for any of the spousal survivor benefits payable with respect to the Participant's benefits under the Plan.

1. Alternate Payee Treated as Spouse For All Spousal Survivor Benefits

The Alternate Payee shall be treated as the Participant's spouse under the Plan for purposes of §§401(a)(11) and 417 of the Code.

2. Alternate Payee Treated as Spouse For a Portion of the Spousal Survivor Benefits

The Alternate Payee shall be treated as the Participant's spouse under the Plan for purposes of §§401(a)(11) and 417 of the Code with respect to [insert percentage of benefit or a formula, such as a formula describing the benefit earned under the plan during marriage].

3. Alternate Payee not Treated as Spouse

The Alternate Payee shall not be treated as the Participant's spouse under the Plan.

[iii] Qualified plans and TSAs.--

If a portion of the benefits of a participant in a qualified plan or TSA is distributed to a spouse or former spouse, the participant's basis in the plan is apportioned between the participant and the spouse or former spouse in proportion to the present values of the benefits payable to each (Code Secs. 72(m)(10) and 414(p)(9)). The law provides that present values are to be determined as of a date to be prescribed in regulations, but such regulations have not been issued. It appears, however, that the allocation should be made at the first moment when it is logically required under the tax law and the provisions of the QDRO.

Example: Fred and Anne Haynes are divorced. Under the provisions of the divorce decree which qualifies as a QDRO, when Fred reaches age 55, Anne will begin to receive a life annuity based on 30% of the value of Fred's then accrued benefit in a qualified plan of Acme Corporation. When Fred actually retires from Acme, he will be entitled to receive a life annuity based on his then accrued benefit less the value as of his 55th birthday of the benefit payable to Anne. If Fred has a basis in his benefits under the plan, it should be allocated as of Fred's 55th birthday. It is then that Anne must determine her exclusion percentage for her life annuity (see ¶6114.02). The remaining basis allocated to Fred, plus any other basis generated after his 55th birthday, would be used by Fred in determining his exclusion percentage when he actually retires.

[iv] Q-3: What is an eligible rollover distribution?

Q-4: Are there other amounts that are not eligible rollover distributions?

Q-5: For purposes of determining whether a distribution is an eligible rollover distribution, how is it determined whether a series of payments is a series of substantially equal periodic payments over a period specified in section 402(c)(4)(A)?

Q-6: What types of variations in the amount of a payment cause the payment to be independent of a series of substantially equal periodic payments and thus not part of the series?

Q-7: When is a distribution from a plan a required minimum distribution under section 401(a)(9)?

Q-8: How are amounts that are not includible in gross income allocated for purposes of determining the required minimum distribution?

Q-9: What is a distribution of a plan loan offset amount and is it an eligible rollover distribution?

Q-10: What is a qualified plan distributed annuity contract, and is an amount paid under such a contract a distribution of the balance to the credit of the employee in a qualified plan for purposes of section 402(c)?

Q-14: How is the $5,000 death benefit exclusion under section 101(b) treated for purposes of determining the amount that is an eligible rollover distribution?

Q-3: What is an eligible rollover distribution?

A-3: (a) General rule. Unless specifically excluded, an eligible rollover distribution means any distribution to an employee (or to a spousal distributee described in Q&A-12(a) of this section) of all or any portion of the balance to the credit of the employee in a qualified plan. Thus, except as specifically provided in Q&A-4(b) of this section, any amount distributed to an employee (or such a spousal distributee) from a qualified plan is an eligible rollover distribution, regardless of whether it is a distribution of a benefit that is protected under section 411(d)(6).

(b) Exceptions. An eligible rollover distribution does not include the following:

(1) Any distribution that is one of a series of substantially equal periodic payments made (not less frequently than annually) over any one of the following periods--

(i) The life of the employee (or the joint lives of the employee and the employee's designated beneficiary);

(ii) The life expectancy of the employee (or the joint life and last survivor expectancy of the employee and the employee's designated beneficiary); or

(iii) A specified period of ten years or more;

(2) Any distribution to the extent the distribution is a required minimum distribution under section 401(a)(9); or

(3) The portion of any distribution that is not includible in gross income (determined without regard to the exclusion for net unrealized appreciation described in section 402(e)(4)). Thus, for example, an eligible rollover distribution does not include the portion of any distribution that is excludible from gross income under section 72 as a return of the employee's investment in the contract (e.g., a return of the employee's after-tax contributions), but does include net unrealized appreciation.

Q-4: Are there other amounts that are not eligible rollover distributions?

A-4: Yes. The following amounts are not eligible rollover distributions:

(a) Elective deferrals, as defined in section 402(g)(3), that, pursuant to §1.415-6(b)(6)(iv), are returned as a result of the application of the section 415 limitations, together with the income allocable to these corrective distributions.

(b) Corrective distributions of excess deferrals as described in §1.402(g)-1(e)(3), together with the income allocable to these corrective distributions.

(c) Corrective distributions of excess contributions under a qualified cash or deferred arrangement described in §1.401(k)-1(f)(4) and excess aggregate contributions described in §1.401(m)-1(e)(3), together with the income allocable to these distributions.

(d) Loans that are treated as deemed distributions pursuant to section 72(p).

(e) Dividends paid on employer securities as described in section 404(k).

(f) The costs of life insurance coverage (P.S. 58 costs).

(g) Similar items designated by the Commissioner in revenue rulings, notices, and other guidance published in the Internal Revenue Bulletin. See §601.601(d)(2)(ii)(b) of this chapter.

A-5: (a) General rule. Generally, whether a series of payments is a series of substantially equal periodic payments over a specified period is determined at the time payments begin, and by following the principles of section 72(t)(2)(A)(iv), without regard to contingencies or modifications that have not yet occurred. Thus, for example, a joint and 50-percent survivor annuity will be treated as a series of substantially equal payments at the time payments commence, as will a joint and survivor annuity that provides for increased payments to the employee if the employee's beneficiary dies before the employee. Similarly, for purposes of determining if a disability benefit payment is part of a series of substantially equal payments for a period described in section 402(c)(4)(A), any contingency under which payments cease upon recovery from the disability may be disregarded.

(b) Certain supplements disregarded. For purposes of determining whether a distribution is one of a series of payments that are substantially equal, social security supplements described in section 411(a)(9) are disregarded. For example, if a distributee receives a life annuity of $500 per month, plus a social security supplement consisting of payments of $200 per month until the distributee reaches the age at which social security benefits of not less than $200 a month begin, the $200 supplemental payments are disregarded and, therefore, each monthly payment of $700 made before the social security age and each monthly payment of $500 made after the social security age is treated as one of a series of substantially equal periodic payments for life. A series of payments that are not substantially equal solely because the amount of each payment is reduced upon attainment of social security retirement age (or, alternatively, upon commencement of social security early retirement, survivor, or disability benefits) will also be treated as substantially equal as long as the reduction in the actual payments is level and does not exceed the applicable social security benefit.

(c) Changes in the amount of payments or the distributee. If the amount (or, if applicable, the method of calculating the amount) of the payments changes so that subsequent payments are not substantially equal to prior payments, a new determination must be made as to whether the remaining payments are a series of substantially equal periodic payments over a period specified in Q&A-3(b)(1) of this section. This determination is made without taking into account payments made or the years of payment that elapsed prior to the change. However, a new determination is not made merely because, upon the death of the employee, the spouse or former spouse of the employee becomes the distributee. Thus, once distributions commence over a period that is at least as long as either the first annuitant's life or 10 years (e.g., as provided by a life annuity with a five-year or ten-year-certain guarantee), then substantially equal payments to the survivor are not eligible rollover distributions even though the payment period remaining after the death of the employee is or may be less than the period described in section 402(c)(4)(A). For example, substantially equal periodic payments made under a life annuity with a five-year term certain would not be an eligible rollover distribution even when paid after the death of the employee with three years remaining under the term certain.

(d) Defined contribution plans. The following rules apply in determining whether a series of payments from a defined contribution plan constitute substantially equal periodic payments for a period described in section 402(c)(4)(A):

(1) Declining balance of years. A series of payments from an account balance under a defined contribution plan will be considered substantially equal payments over a period if, for each year, the amount of the distribution is calculated by dividing the account balance by the number of years remaining in the period. For example, a series of payments will be considered substantially equal payments over 10 years if the series is determined as follows. In year 1, the annual payment is the account balance divided by 10; in year 2, the annual payment is the remaining account balance divided by 9; and so on until year 10 when the entire remaining balance is distributed.

(2) Reasonable actuarial assumptions. If an employee's account balance under a defined contribution plan is to be distributed in annual installments of a specified amount until the account balance is exhausted, then, for purposes of determining if the period of distribution is a period described in section 402(c)(4)(A), the period of years over which the installments will be distributed must be determined using reasonable actuarial assumptions. For example, if an employee has an account balance of $100,000, elects distributions of $12,000 per year until the account balance is exhausted, and the future rate of return is assumed to be 8% per year, the account balance will be exhausted in approximately 14 years. Similarly, if the same employee elects a fixed annual distribution amount and the fixed annual amount is less than or equal to $10,000, it is reasonable to assume that a future rate of return will be greater than 0% and, thus, the account will not be exhausted in less than 10 years.

(e) Series of payments beginning before January 1, 1993. Except as provided in paragraph (c) of this Q&A, if a series of periodic payments began before January 1, 1993, the determination of whether the post-December 31, 1992 payments are a series of substantially equal periodic payments over a specified period is made by taking into account all payments made, including payments made before January 1, 1993. For example, if a series of substantially equal periodic payments beginning on January 1, 1983, is scheduled to be paid over a period of 15 years, payments in the series that are made after December 31, 1992, will not be eligible rollover distributions even though they will continue for only five years after December 31, 1992, because the pre-January 1, 1993 payments are taken into account in determining the specified period.

Q-6: What types of variations in the amount of a payment cause the payment to be independent of a series of substantially equal periodic payments and thus not part of the series?

A-6: (a) Independent payments. Except as provided in paragraph (b) of this Q&A, a payment is treated as independent of the payments in a series of substantially equal payments, and thus not part of the series, if the payment is substantially larger or smaller than the other payments in the series. An independent payment is an eligible rollover distribution if it is not otherwise excepted from the definition of eligible rollover distribution. This is the case regardless of whether the payment is made before, with, or after payments in the series. For example, if an employee elects a single payment of half of the account balance with the remainder of the account balance paid over the life expectancy of the distributee, the single payment is treated as independent of the payments in the series and is an eligible rollover distribution unless otherwise excepted. Similarly, if an employee's surviving spouse receives a survivor life annuity of $1,000 per month plus a single payment on account of death of $7,500, the single payment is treated as independent of the payments in the annuity and is an eligible rollover distribution unless otherwise excepted (e.g., $5,000 of the $7,500 might qualify to be excluded from gross income as a death benefit under section 101(b)).

(b) Special rules--(1) Administrative error or delay. If, due solely to reasonable administrative error or delay in payment, there is an adjustment after the annuity starting date to the amount of any payment in a series of payments that otherwise would constitute a series of substantially equal payments described in section 402(c)(4)(A) and this section, the adjusted payment or payments will be treated as part of the series of substantially equal periodic payments and will not be treated as independent of the payments in the series. For example, if, due solely to reasonable administrative delay, the first payment of a life annuity is delayed by two months and reflects an additional two months worth of benefits, that payment will be treated as a substantially equal payment in the series rather than as an independent payment. The result will not change merely because the amount of the adjustment is paid in a separate supplemental payment.

(2) Supplemental payments for annuitants. A supplemental payment from a defined benefit plan to annuitants (e.g., retirees or beneficiaries) will be treated as part of a series of substantially equal payments, rather than as an independent payment, provided that the following conditions are met--

(i) The supplement is a benefit increase for annuitants;

(ii) The amount of the supplement is determined in a consistent manner for all similarly situated annuitants;

(iii) The supplement is paid to annuitants who are otherwise receiving payments that would constitute substantially equal periodic payments; and

(iv) The aggregate supplement is less than or equal to the greater of 10% of the annual rate of payment for the annuity, or $750 or any higher amount prescribed by the Commissioner in revenue rulings, notices, and other guidance published in the Federal Register. See §601.601(d)(2)(ii)(b) of this chapter.

(3) Final payment in a series. If a payment in a series of payments from an account balance under a defined contribution plan represents the remaining balance to the credit and is substantially less than the other payments in the series, the final payment must nevertheless be treated as a payment in the series of substantially equal payments and may not be treated as an independent payment if the other payments in the series are substantially equal and the payments are for a period described in section 402(c)(4)(A) based on the rules provided in paragraph (d)(2) of Q&A-5 of this section. Thus, such final payment will not be an eligible rollover distribution.

Q-7: When is a distribution from a plan a required minimum distribution under section 401(a)(9)?

A-7: (a) General rule. Except as provided in paragraphs (b) and (c) of this Q&A, if a minimum distribution is required for a calendar year, the amounts distributed during that calendar year are treated as required minimum distributions under section 401(a)(9), to the extent that the total required minimum distribution under section 401(a)(9) for the calendar year has not been satisfied. Accordingly, these amounts are not eligible rollover distributions. For example, if an employee is required under section 401(a)(9) to receive a required minimum distribution for a calendar year of $5,000 and the employee receives a total of $7,200 in that year, the first $5,000 distributed will be treated as the required minimum distribution and will not be an eligible rollover distribution and the remaining $2,200 will be an eligible rollover distribution if it otherwise qualifies. If the total section 401(a)(9) required minimum distribution for a calendar year is not distributed in that calendar year (e.g., when the distribution for the calendar year in which the employee reaches age 70 1/2 is made on the following April 1), the amount that was required but not distributed is added to the amount required to be distributed for the next calendar year in determining the portion of any distribution in the next calendar year that is a required minimum distribution.

(b) Distribution before age 70 1/2. Any amount that is paid before January 1 of the year in which the employee attains (or would have attained) age 70 1/2 will not be treated as required under section 401(a)(9) and, thus, is an eligible rollover distribution if it otherwise qualifies.

(c) Special rule for annuities. In the case of annuity payments from a defined benefit plan, or under an annuity contract purchased from an insurance company (including a qualified plan distributed annuity contract (as defined in Q&A-10 of this section)), the entire amount of any such annuity payment made on or after January 1 of the year in which an employee attains (or would have attained) age 70 1/2 will be treated as an amount required under section 401(a)(9) and, thus, will not be an eligible rollover distribution.

Q-8: How are amounts that are not includible in gross income allocated for purposes of determining the required minimum distribution?

A-8: If section 401(a)(9) has not yet been satisfied by the plan for the year with respect to an employee, a distribution is made to the employee that exceeds the amount required to satisfy section 401(a)(9) for the year for the employee, and a portion of that distribution is excludible from gross income, the following rule applies for purposes of determining the amount of the distribution that is an eligible rollover distribution. The portion of the distribution that is excludible from gross income is first allocated toward satisfaction of section 401(a)(9) and then the remaining portion of the required minimum distribution, if any, is satisfied from the portion of the distribution that is includible in gross income. For example, assume an employee is required under section 401(a)(9) to receive a minimum distribution for a calendar year of $4,000 and the employee receives a $4,800 distribution, of which $1,000 is excludible from income as a return of basis. First, the $1,000 return of basis is allocated toward satisfying the required minimum distribution. Then, the remaining $3,000 of the required minimum distribution is satisfied from the $3,800 of the distribution that is includible in gross income, so that the remaining balance of the distribution, $800, is an eligible rollover distribution if it otherwise qualifies.

Q-9: What is a distribution of a plan loan offset amount, and is it an eligible rollover distribution?

A-9: (a) General rule. A distribution of a plan loan offset amount, as defined in paragraph (b) of this Q&A, is an eligible rollover distribution if it satisfies Q&A-3 of this section. Thus, an amount equal to the plan loan offset amount can be rolled over by the employee (or spousal distributee) to an eligible retirement plan within the 60-day period under section 402(c)(3), unless the plan loan offset amount fails to be an eligible rollover distribution for another reason. See §1.401(a)(31)-1, Q&A-15 for guidance concerning the offering of a direct rollover of a plan loan offset amount. See §31.3405(c)-1, Q&A-11 of this chapter for guidance concerning special withholding rules with respect to plan loan offset amounts.

(b) Definition of plan loan offset amount. For purposes of section 402(c), a distribution of a plan loan offset amount is a distribution that occurs when, under the plan terms governing a plan loan, the participant's accrued benefit is reduced (offset) in order to repay the loan (including the enforcement of the plan's security interest in a participant's accrued benefit). A distribution of a plan loan offset amount can occur in a variety of circumstances, e.g., where the terms governing a plan loan require that, in the event of the employee's termination of employment or request for a distribution, the loan be repaid immediately or treated as in default. A distribution of a plan loan offset amount also occurs when, under the terms governing the plan loan, the loan is cancelled, accelerated, or treated as if it were in default (e.g., where the plan treats a loan as in default upon an employee's termination of employment or within a specified period thereafter). A distribution of a plan loan offset amount is an actual distribution, not a deemed distribution under section 72(p).

(c) Examples. The rules with respect to a plan loan offset amount in this Q&A-9, §1.401(a)(31)-1, Q&A-15 and §31.3405(c)-1, Q&A-11 of this chapter are illustrated by the following examples:

Example 1. (a) In 1996, Employee A has an account balance of $10,000 in Plan Y, of which $3,000 is invested in a plan loan to Employee A that is secured by Employee A's account balance in Plan Y. Employee A has made no after-tax employee contributions to Plan Y. Plan Y does not provide any direct rollover option with respect to plan loans. Upon termination of employment in 1996, Employee A, who is under age 70 1/2, elects a distribution of Employee A's entire account balance in Plan Y, and Employee A's outstanding loan is offset against the account balance on distribution. Employee A elects a direct rollover of the distribution.

(b) In order to satisfy section 401(a)(31), Plan Y must pay $7,000 directly to the eligible retirement plan chosen by Employee A in a direct rollover. When Employee A's account balance was offset by the amount of the $3,000 unpaid loan balance, Employee A received a plan loan offset amount (equivalent to $3,000) that is an eligible rollover distribution. However, under §1.401(a)(31)-1, Q&A-15 Plan Y satisfies section 401(a)(31), even though a direct rollover option was not provided with respect to the $3,000 plan loan offset amount.

(c) No withholding is required under section 3405(c) on account of the distribution of the $3,000 plan loan offset amount because no cash or other property (other than the plan loan offset amount) is received by Employee A from which to satisfy the withholding. Employee A may roll over $3,000 to an eligible retirement plan within the 60 day period provided in section 402(c)(3).

Example 2. (a) The facts are the same as in Example 1, except that the terms governing the plan loan to Employee A provide that, upon termination of employment, Employee A's account balance is automatically offset by the amount of any unpaid loan balance to repay the loan. Employee A terminates employment but does not request a distribution from Plan Y. Nevertheless, pursuant to the terms governing the plan loan, Employee A's account balance is automatically offset by the amount of the $3,000 unpaid loan balance.

(b) The $3,000 plan loan offset amount attributable to the plan loan in this example is treated in the same manner as the $3,000 plan loan offset amount in Example 1.

Example 3. (a) The facts are the same as in Example 2, except that, instead of providing for an automatic offset upon termination of employment to repay the plan loan, the terms governing the plan loan require full repayment of the loan by Employee A within 30 days of termination of employment. Employee A terminates employment, does not elect a distribution from Plan Y, and also fails to repay the plan loan within 30 days. The plan administrator of Plan Y declares the plan loan to Employee A in default and executes on the loan by offsetting Employee A's account balance by the amount of the $3,000 unpaid loan balance.

(b) The $3,000 plan loan offset amount attributable to the plan loan in this example is treated in the same manner as the $3,000 plan loan offset amount in Example 1 and in Example 2. The result in this Example 3 is the same even though the plan administrator treats the loan as in default before offsetting Employee A's accrued benefit by the amount of the unpaid loan.

Example 4. (a) The facts are the same as in Example 1, except that Employee A elects to receive the distribution of the account balance that remains after the $3,000 offset to repay the plan loan, instead of electing a direct rollover of the remaining account balance.

(b) In this case, the amount of the distribution received by Employee A is $10,000, not $3,000. Because the amount of the $3,000 offset attributable to the loan is included in determining the amount that equals 20 percent of the eligible rollover distribution received by Employee A, withholding in the amount of $2,000 (20 percent of $10,000) is required under section 3405(c). The $2,000 is required to be withheld from the $7,000 to be distributed to Employee A in cash, so that Employee A actually receives a check for $5,000.

Example 5. The facts are the same as in Example 4, except that the $7,000 distribution to Employee A after the offset to repay the loan consists solely of employer securities within the meaning of section 402(e)(4)(E). In this case, no withholding is required under section 3405(c) because the distribution consists solely of the $3,000 plan loan offset amount and the $7,000 distribution of employer securities. This is the result because the total amount required to be withheld does not exceed the sum of the cash and the fair market value of other property distributed, excluding plan loan offset amounts and employer securities. Employee A may roll over the employer securities and $3,000 to an eligible retirement plan within the 60-day period provided in section 402(c)(3).

Example 6. Employee B, who is age 40, has an account balance in Plan Z, a profit sharing plan qualified under section 401(a) that includes a qualified cash or deferred arrangement described in section 401(k). Plan Z provides for no after-tax employee contributions. In 1990, Employee B receives a loan from Plan Z, the terms of which satisfy section 72(p)(2), and which is secured by elective contributions subject to the distribution restrictions in section 401(k)(2)(B). In 1996, the loan fails to satisfy section 72(p)(2) because Employee B stops repayment. In that year, pursuant to section 72(p), Employee B is taxed on a deemed distribution equal to the amount of the unpaid loan balance. Under Q&A-4 of this section, the deemed distribution is not an eligible rollover distribution. Because Employee B has not separated from service or experienced any other event that permits the distribution under section 401(k)(2)(B) of the elective contributions that secure the loan, Plan Z is prohibited from executing on the loan. Accordingly, Employee B's account balance is not offset by the amount of the unpaid loan balance at the time Employee B stops repayment on the loan. Thus, there is no distribution of an offset amount that is an eligible rollover distribution in 1996.

A-10: (a) Definition of a qualified plan distributed annuity contract. A qualified plan distributed annuity contract is an annuity contract purchased for a participant, and distributed to the participant, by a qualified plan.

(b) Treatment of amounts paid as eligible rollover distributions. Amounts paid under a qualified plan distributed annuity contract are payments of the balance to the credit of the employee for purposes of section 402(c) and are eligible rollover distributions, if they otherwise qualify. Thus, for example, if the employee surrenders the contract for a single sum payment of its cash surrender value, the payment would be an eligible rollover distribution to the extent it is includible in gross income and not a required minimum distribution under section 401(a)(9). This rule applies even if the annuity contract is distributed in connection with a plan termination. See §1.401(a)(31)-1, Q&A-16 and §31.3405(c)-1, Q&A-13 of this chapter concerning the direct rollover requirements and 20-percent withholding requirements, respectively, that apply to eligible rollover distributions from such an annuity contract.

Q-14: How is the $5,000 death benefit exclusion under section 101(b) treated for purposes of determining the amount that is an eligible rollover distribution?

A-14: To the extent that a death benefit is a distribution from a qualified plan, the portion of the distribution that is excluded from gross income under section 101(b) is not an eligible rollover distribution. See §1.401(a)(31)-1, Q&A-17 for guidance concerning assumptions that a plan administrator may make with respect to whether and to what extent a distribution of a survivor benefit is excludible from gross income under section 101(b).

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