When an employee stock ownership plan (ESOP) plan sponsor becomes aware that a participant is undergoing a divorce, there may be questions of what this means for the ESOP and what actions are required of the plan administrator. To properly handle such a situation, one must first understand what notification they will receive and then act accordingly. Whether this is your first time encountering this situation or you simply need a refresher, this article will cover the basics of qualified domestic relations orders (QDROs) and the steps to take when your ESOP receives one.
What Are QDROs?
Just as assets are divided among spouses during a divorce, benefits of a retirement plan—such as an ESOP—may be divided as well. Such retirement benefits are only allocated if the ruling is a QDRO. A domestic relations order (DRO) is not equivalent to a QDRO, which is a critical distinction in knowing whether you must continue your efforts. A DRO is a legal ruling under state law concerning an individual providing child support, payments of alimony, or ownership and rights of property obtained in marriage that benefit a child, ex-spouse, spouse, or additional dependent of the participant. A DRO can designate some or all of the benefits of a retirement plan participant. However, only after deciding that the ruling is a QDRO can a distribution occur. It is important to note that a QDRO is not permitted to mandate a payment greater than the vested balance of the participant, nor can it dictate benefits to be paid from a previous QDRO.
To be considered a QDRO, the ruling is given by a state authority, and the ruling details the following: the name and most recent postal address of the plan’s participant and the alternate recipients, the name of the retirement plan(s) the DRO includes, the amount—whether percentage, dollar, or formula for determining such—to be paid to the alternate recipients, and the time frame or number of payments the DRO is applicable for. If you are aware of a participant undergoing a divorce but have not received the DRO, you should ask for this document and refrain from activity affecting the participant’s account until receiving such and determining if a QDRO exists. It is the plan administrator’s responsibility to determine if the DRO meets the requirements of a QDRO.
Administrative Steps Needed Next
Should you receive a DRO, you must notify the affected plan participant and alternate(s) that you have received the order, along with the steps of how the plan will determine if it is qualified. You have an 18-month “determination period” to alert the parties, establish if the DRO is qualified, and split accounts as needed prior to any payment of benefits. The period begins on the date that the first payment would be required to be paid under the order. As for tax implications, children and dependents do not pay taxes on the distribution—the original participant does. For spouses and ex-spouses, through a ratio allocation, they will report distributions received as though they were participants in the plan. However, spouses and ex-spouses have the potential to take advantage of the tax benefits of a rollover as if they were the original participant.
In the case of a QDRO, the participant’s account will be divided according to its provisions and the timing of a distribution will be established. Alternate payees are now treated as plan beneficiaries and should be given the summary annual report, summary plan description (SPD), and any summary of material changes made. If immediate payment is not being made, benefits must be paid to alternates as determined by the plan document. The IRS requires benefits to be paid no later than the date the plan participant reaches “earliest retirement age.” This is characterized as the earlier of (1) the date the participant is entitled to a distribution according to the plan or (2) the later of the participant turning 50 or the first date they could start collecting plan benefits if terminated or there is a break in service.
Summary
QDROs can be a complex element of ESOP administration, especially if proper guidelines are not in place for their administration. It is important to understand the basics of what they are and their effects to help serve ESOP participants while maintaining compliance. If you have any questions or need assistance, please reach out to a professional at Forvis Mazars.