Professional negligence. The word strikes fear in the heart of even the most experienced attorney. While attorneys do not intentionally set out to make mistakes that expose them to liability, a lack of knowledge often causes unintentional mistakes that lead to bigger problems down the road.
After ten years of working with attorneys and their clients to prepare Qualified Domestic Relations Orders (QDROs) and other paperwork for the retirement account division, I have seen, firsthand, some very common mistakes made when it comes to deal with these complex documents. .
Omission of key terms in the separation agreement
One of the most common problems is that the Separation Agreement is too vague when it comes to the division of retirement assets. This often leads to costly post-trial litigation, sometimes years later. These problems can be avoided by clearly setting out all the relevant terms of any division of retirement assets within the body of the final Separation Agreement. Wave statements like “XYZ pension will be divided between the parties and a QDRO will be prepared” is not enough. Key topics such as survival benefits, valuation date, valuation method, etc. it must be fully detailed in the Separation Agreement.
Failure to make a proper discovery
Another error-prone area is that there is no clear understanding of what a plan will allow, and more importantly, will not allow in terms of distribution. By obtaining and reviewing a complete copy of the governing plan documents at the outset, limitations and prohibitions can be identified, before negotiations begin. I have seen many cases where, after lengthy and costly negotiations, the parties finally agree to split a certain account, only to find out when the QDRO is being prepared that the plan will not allow the agreed terms.
Not presenting the order correctly
In most cases, a proposed QDRO will be sent to the Plan Administrator for review. Unfortunately, this is where the ball is often dropped. Whether the Plan Administrator approves or rejects the proposed order in that initial review, eventually the court will sign a final QDRO. This final QDRO should be sent to the plan administrator. Failure to file the final QDRO with the Plan Administrator, and follow up until funds are distributed, may result in the Alternate Payee losing their rights under the QDRO. It is important to keep track of each QDRO until the distribution can be validated.
Incorrect delegation of responsibility for writing QDRO
Often times, the attorney representing the plan participant will pass the responsibility of preparing the QDRO to the alternate payee and their attorney. After all, it is the other party that wants some of the participant’s asset. However, this is shortsighted. Since a QDRO can be written to either favor or harm either party, it is important that both parties and their attorneys take an active role in preparing the document.
In more than a few cases, the responsibility for preparing the QDRO is never formally assigned to either party. This puts everyone at risk as the QDRO may never be ready and eventually completely forgotten. This puts the rights of the alternate payee at risk and, in some cases, they will never receive their share of the asset.
Failure to adequately explain QDRO terms
Since the QDRO may contain favorable or unfavorable terms for either party, everyone should have a clear understanding of the exact details related to how the account will be divided. Misconceptions lead to incorrect assumptions that can lead to dissatisfied customers in the future.
Confidence in the ways of the plan
While an alarming number of attorneys blindly rely on the “fill in the blanks” QDRO forms provided by some plans, this is a dangerous approach. These forms are created to make execution as easy as possible for the plan administrator, rather than focusing on the best interest of any one of the clients. As other distribution options may be available, it is important to fully understand all the possibilities before relying exclusively on preprinted Plan forms.
Not understanding survival issues
Many attorneys are unfamiliar with the different options related to survivor benefits and protections. As a result, the Separation Agreement may contain only generic language regarding the right to survivor benefits. In some cases, this language is never transferred to the actual QDRO, which creates major problems in the future.
Attorneys should consider all of the following potential scenarios when writing survivorship language:
What will the former spouse / alternate beneficiary be entitled to if the plan participant dies before retirement?
What will the former spouse / alternate beneficiary be entitled to if the plan participant dies after retirement?
What happens if the former spouse / alternate payee dies before the plan participant?
Incorrectly analyzing present value
When a pension plan is the primary asset of a marital estate, a present value calculation may not even be necessary, since asset division is the only issue at stake. However, when the marital estate includes many assets, and the pension plan is only one, correctly calculating the present value of the pension plan becomes more important.
The present value calculation is performed by an actuary who uses a basic plan risk formula, an applied discount rate, and the application of a mortality table. The resulting value will be influenced by additional factors that are specific to the plan and the participant. These include the existence of previous QDROs, early retirement allowances, compensation history, probability of disability, etc.
It is important to consider all of these factors when advising a client whether to seek immediate compensation of the value of the pension with other marital assets or, instead, accept deferred distribution when the plan participant retires.
Inadequate understanding and explanation of tax implications
Money distributed from a qualified plan to the alternate payee’s spouse is subject to ordinary income tax, unless rolled over to an IRA. However, the original distribution is not subject to the 10% early withdrawal penalty, even if the alternate payee is under 59 1/2.
However, if the alternate payee rolls over everything and then withdraws some of the money from their new IRA, the early withdrawal penalty may apply. In many cases, the alternate payee will do exactly this to cover attorney’s fees or other debts. It is important for the alternate payee to understand when and how the penalty is applied so that they can make informed decisions before the original distribution occurs.