The CPA's Role in QDROs
IMGCAP(1)]For some accountants, the only QDRO they will see will be part of their own divorce decree. But for many others, advising on QDROs is a part of their practice.
A QDRO—short for “qualified domestic relations order” and pronounced “quad row”—is a judgment, decree or order for a retirement plan to pay child support, alimony or marital property rights to a spouse, former spouse, child or other dependent of a participant. For Connie Buffington, of counsel at Atlanta-based Boyd Collar Nolen & Tuggle, it is a very important tool in the context of a divorce.
“Its purpose is to allow the parties to a divorce to divide their marital interests and qualified retirement assets that are held in qualified plans governed by ERISA [the Employment Retirement Income Security Act of 1974] to be divided without any tax consequences,” she said.
ERISA and the Internal Revenue Code do not permit a plan participant to make early withdrawals of plan assets without penalty, she explained. “As an exception, assets held in qualified retirement plans may be divided without penalty for purposes of child support, alimony or equitable division of marital property through the use of a Domestic Relations Order which, once accepted—or ‘qualified’—by the administrator of the plan in which the account is held, is known as a qualified domestic relations order, or QDRO.”
“CPAs can play an invaluable role in drafting a QDRO,” said Buffington. “Accountants can really help. We generally want an across the board pro rata slice to go to the alternate payee, but there may be special circumstances where the CPA believes it’s best to cherry pick certain assets, especially for highly compensated executives who have particularly valuable stock awards that might be held in their 401(k)plan or who have made post-tax contributions to their 401(k) plan.”
“We work with an accounting professional in every single high net worth case we have, because we rely on their advice to help us value the total marital balance sheet,” she added.
“We generally want an across-the-board prorate slice to go to the alternate payee [the spouse in a divorce situation], but there may be special circumstances when the CPA may believe it best to cherry pick certain assets,” she said. “That’s generally with highly compensated executives who have particularly valuable stock awards that might get dumped into a qualified plan as part of their 401(k). Too often, the division of marital retirement assets is handled almost as an afterthought based on the assumption that in every case, it is enough to agree to simply slice the traditional retirement assets down the middle.”
A common issue, particularly in today’s economy, is the need for one of the parties to take a cash distribution at the time of the divorce from the retirement asset they’re receiving by QDRO, Buffington noted. “The reality is that divorce often creates a huge financial crisis,” she said. “We have situations where the retirement assets are the only assets that have been saved. All the other assets have been eroded. Since the division of the assets typically occurs at the conclusion of the case, as a practical matter the parties are looking at the need for a new home, funds to pay their attorney and CPA, get out of debt and start a new life. Accountants play a very important role by helping us structure settlement agreements in ways that account for the tax consequences of encroaching on retirement assets.”
That’s why it’s important to “anticipate, address and allocate” tax liability that may arise from cash distributions taken on a QDRO transfer, Buffington observed. “A straightforward rollover from the account holder’s qualified defined contribution plan, for example, a 401(k) plan to a retirement account designated by the former spouse, is a non-taxable event,” she explained. “But any time the former spouse elects to take all or a portion of their benefit in cash, taxation issues arise. With timely advice, the tax consequences of cash distributions can be substantially minimized, and in some cases allocated between the parties by agreement.”