QDROs & Loans: How Loans on Retirement Accounts Affect Divorce
RETIREMENT PLAN LOANS & DIVORCE
Participants in defined contribution retirement plans often have the option of taking out loans. These loans are usually paid back via paycheck deductions over a period of years and these loans usually cannot be assigned to any other party for repayment. If a defined contribution plan, such as a 401(k), is divided during a divorce or legal separation, it is critical to address any outstanding loans.
HOW TO FIND OUT IF THERE IS AN OUTSTANDING LOAN
You should first look for an outstanding loan balance on the account statement. Sometimes there will be a clearly labeled section for loans. Other statements can be a bit more difficult to read, for example a statement may show an “account balance” of $25,000 but list the “total account value” at $35,000 elsewhere, which would indicate a $10,000 outstanding loan. Plan administrator’s usually consider outstanding loans as assets which should be added to the value of the account to determine the account’s true value. The participant in the plan is also required to make full disclosure of assets and obligations during a divorce and the marital settlement agreement should clearly address outstanding loans. If the participant represents that there are no loans, the settlement agreement should include a statement that the party “represents and warrants that he/she has not taken any loans or withdrawals from the [insert plan name] account, and he/she shall be prohibited from taking any loans or withdrawals until a QDRO is implemented by the plan, creating a separate interest for [the other party].” If a withdrawal or loan, in violation of the automatic temporary restraining order, is feared by the non-employee spouse a notice of adverse interest to the plan, or a joinder, will often cause a hold to be placed on the participant’s account pending receipt of a QDRO by the plan administrator.
IS A LOAN SEPARATE PROPERTY OR COMMUNITY PROPERTY?
If there is an outstanding loan, it must be determined whether the loan is community or separate property. Parties sometimes view any loan taken out from the date of marriage through the date of separation as community property; other parties will agree to look at what the loan funds were used for to determine if the loan is community property or separate property.
Separate Property Loans in QDROs
If a loan is determined to be the participant’s separate property, then the QDRO needs to be drafted carefully to award the correct amount to the former spouse (or “alternate payee”). For example, if a QDRO awards 50% of the participant’s account balance to the alternate payee as of the parties’ date of separation, but does not address loans, the alternate payee’s share could unintentionally be reduced by the value of the outstanding loan. By way of an example, if the account balance at the date of separation was $50,000, but there was an outstanding loan of $10,000, which would bring the total account value to $60,000, then the alternate payee may accidentally be awarded $25,000, instead of the $30,000 to which she is entitled due to a separate property loan. To ensure that the alternate payee’s share is not reduced by the other party’s separate property loan, the QDRO must include the loan balance in the account balance prior to calculating the 50% award to the alternate payee.
Community Property Loans in QDROs
Since it is usually not possible to make an alternate payee responsible for loan repayment under a QDRO, if a loan is determined to be community property, the QDRO must be carefully drafted to ensure that the alternate payee’s share of the account is reduced by an equal portion of the outstanding community property loan.
POTENTIAL FOR QDRO REJECTION DUE TO OUTSTANDING PLAN LOANS
Most retirement plans will not distribute funds in excess of the outstanding loan. If the parties have agreed to equalize assets and award the alternate payee 100% of the participant’s account, they should determine exactly what the dollar amount of the distribution will be under the terms of the plan before filing the QDRO. For example, if there is $30,000 in an account, plus a $5,000 outstanding loan, the plan will likely only distribute a maximum of $25,000 to the alternate payee. Alternatively, if a QDRO awards the alternate payee $30,000 in the same example, the QDRO will likely be rejected by the plan because the maximum that can be distributed under the plan’s terms would be $25,000.
QUESTIONS ABOUT LOANS AND QDROs?
If you have questions about the division of defined contribution plan accounts due to your California dissolution of marriage or legal separation please call QDRO Helper at (619) 786-QDRO / (619) 786-7376. You can also request a new client package by sending an email to firstname.lastname@example.org.
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