Introduction

The purpose of this article is to provide methods for calculating benefits payable under a separate interest Qualified Domestic Relations Order (QDRO) when a pension plan offers subsidized early retirement.

A QDRO is a court order that assigns a portion of a participant’s benefit to an alternate payee (AP). An AP can be a spouse, former spouse, child, or other dependent of the participant.

In general, there are two categories of QDROs, shared payment and separate interest.

• In a shared payment arrangement, the participant’s actual benefit payments are divided between the participant and the AP. Generally, shared payment QDROs are used only after a participant is already in pay status. Therefore, it is irrelevant whether an early retirement subsidy is involved. The benefit is calculated as if there were no QDRO, and the specified portion of the participant’s payment is paid to the AP.
• In a separate interest arrangement, a portion of the participant’s retirement benefit is assigned to the AP and is payable based on the AP’s lifetime. The AP may choose to commence benefits at a different time and in a different form of payment than the participant. In contrast to a shared payment, the calculations involved in separate interest QDROs can be complicated, especially if the plan offers subsidies.

The focus of this article is separate interest arrangements.

Separate interest QDROs

The applicable provisions of the Internal Revenue Code provide that a QDRO be drafted in a way that it “does not require the plan to provide increased benefits (determined on the basis of actuarial value).”¹ Therefore, benefits payable to an AP under a separate interest QDRO should be adjusted for the difference in life expectancy between the participant and the AP. For example, a benefit of $1,000 per month payable to a 65-year-old participant does not have the same actuarial value as $1,000 per month payable to a 55-year-old spouse because the spouse is expected to live longer and receive more payments. To have the same actuarial value, the benefit payable to the spouse would have to be reduced.

If the pension plan offers subsidized early retirement, then the value of the subsidy may need to be taken into consideration when determining benefits under a QDRO. In our experience, QDROs either explicitly award the AP a pro-rata share of the early retirement subsidy or are silent on the issue. If the QDRO is silent, one should refer to the plan document, the plan’s QDRO procedures, and/or fund counsel for guidance. It should not simply be assumed that the AP is not entitled to a portion of the early retirement subsidy.

Although opinions may differ by practitioner, we believe the early retirement subsidy exists only if the participant commences early retirement benefits and receives the subsidy. If the AP commences benefits before the participant, then the AP’s benefit will not reflect an early retirement subsidy. Providing the AP with an early retirement subsidy before the participant retires may violate the aforementioned rule against paying increased benefits. If the QDRO awards the AP the subsidy and the participant subsequently commences benefits and receives the subsidy, then the AP’s benefit should be recalculated and increased prospectively to reflect the subsidy.

Finally, if the participant retires on or after normal retirement date (NRD), then there is no early retirement subsidy that must be considered in the calculations.

Basics of separate interest QDRO calculations

The basic calculation steps for a separate interest QDRO are as follows:

For the AP:

1. Determine the amount of participant’s accrued benefit assigned to the AP based on the terms of the QDRO. We will refer to this as the “AP Offset.”
2. Calculate the present value (PV) of the AP Offset.
3. Convert the result in step 2 to an annuity payable to the AP.

For the participant:

1. Calculate the PV of the participant’s total accrued benefit without regard to the AP Offset.
2. Subtract the PV of the AP Offset (step 2 from AP’s calculation) from the result in step 1.
3. Convert the result in step 2 to an annuity payable to the participant.

We will now consider how to calculate benefits under the following scenarios:

• The AP is not entitled to early retirement subsidies.
• The AP is entitled to early retirement subsidies, and
  • Participant and AP commence benefits at same time.
  • Participant commences benefits before AP.
  • Participant commences benefits after AP.

For these scenarios, we have assumed that the participant retires with an early retirement subsidy, the normal form of payment is a single life annuity, and the plan does not offer a lump-sum option.

AP not entitled to early retirement subsidies

When the AP is not entitled to early retirement subsidies, the steps to determine the amount payable to the AP are the same as steps 1, 2, and 3 outlined in the previous section.

The amount payable to the participant should include the value of the early retirement subsidy not awarded to the AP.

AP entitled to early retirement subsidies

When an AP is entitled to early retirement subsidies, the benefit payable to the participant can be calculated as follows:

In contrast, the benefit payable to the AP will depend on the AP’s commencement date relative to that of the participant.

1. Participant and AP commence benefit payments on the same date.

2. Participant commences benefits before AP.

The steps are the same as in #1, except that the immediate annuity factor in step (c) is a deferred annuity factor from participant’s DOC to AP’s DOC.

3. AP commences benefits before participant.

Summary

When calculating the benefits payable to a participant or AP under a QDRO, early retirement subsidies present unique calculation challenges. The benefits determined under a QDRO must not constitute an increase in plan costs. Special attention needs to be given to QDROs when the AP commences benefits prior to the participant because of the potential eligibility for an early retirement subsidy benefit increase. QDROs come in all shapes, sizes, and levels of complexity, and early retirement subsidies along with relative dates of commencement play key roles in determining benefit amounts.