Cash v. Securities – Understanding How to Divide A Defined Contribution Plan

I often receive a request to prepare a QDRO for a defined contribution plan in which I am told that the alternate payee is awarded $50,000.00 “cash” or a “lump sum” of $50,000.00. In relatively rare instances this may actually be the case; however, in most cases it is not. And these words or phrases can be very misleading. 

It’s important to understand that defined contribution plans, (such as 401(k) plans, profit sharing plans, employee stock ownership plans, 457(b) plans, 403(b) plans, etc.) consist of individual accounts in the name of employee/participants, which are then made up of investment sources such as stocks, index funds, brokerage funds, cash, etc. (a.k.a. Fund Mix).

When an alternate payee/former spouse is awarded some amount from the employee/participant’s defined contribution plan, the administrator for the plan will simply move a portion of the account investment sources to an account in the name of the alternate payee/former spouse. Now the former spouse/alternate payee will have a separate account in the plan that is made up of the same fund mix (cash, stock, brokerage funds, index funds, etc.), as the employee/participant.  

In most cases, unless the account is heavily made up of cash, when an alternate payee/former spouse is awarded $50,000.00, it consists of investments which may include some cash but typically more stocks and funds. When the investments are moved into an account for the former spouse/alternate payee, the value of the investments will adjust according to the fund mix and market value. In other words, if you are awarded $50,000.00, by the time the funds are segregated into an account in your name or by the time you liquidate the funds, the value of the $50,000.00 may have increased or decreased as a result of earnings, gains, losses, interest, &/or dividends.     

It’s like being awarded a house in the divorce which has a value of $200,000.00. You didn’t receive $200,000.00 in cash or a lump sum of $200,000.00, you received property with a value of $200,000.00. There is a difference. When you sell the house, you may receive more or less than the $200,000.00.

If the intent is to award the former spouse/alternate payee $50,000.00 worth of value or without earnings, gains, losses, interest, &/or dividends, that can be done.  However, the divorce decree or court order needs to be clear about this. You also need to know that there are risks associated with this type of an award.

If you need more information or have any questions, please message me or contact me at 877-531-8333.