|Deferred Compensation in Divorce
A potential client facing divorce wants to start learning about her family finances, beginning with her husbandís deferred-compensation benefits.
April 21, 2011
Mrs. X, a potential client, tells you that her husband has filed for divorce and she is worried about her financial future. She does not understand his employment benefits but knows he has some nice ones. She remembers there is a deferred-compensation plan but doesn’t know what else he may have. She has the following questions for you.
My husband has always been in charge of the finances. How can I find out about his employment benefits?
First, explain that part of her attorney’s job is gathering documentation during the divorce. That will occur in a process called discovery. This is the information-gathering process of any lawsuit. Discovery includes interrogatories, depositions, requests for admissions, requests for documents, etc. The discovery process takes time. In the meantime, she might already have access to information that will help her become knowledgeable:
What Are Qualified and Nonqualified Plans?
Qualified plans are subject to Employee Retirement Income Security Act of 1974 (ERISA) rules. There are ERISA requirements for participation, vesting and withdrawal for qualified plans. Qualified plans include, but are not limited to, 401(k) accounts and pension plans. Nonqualified plans do not have those same requirements and the employee participant does not have the same benefits or protection as that of qualified plans.
Incentive compensation plans for key high-ranking employees are nonqualified plans. These are supplemental retirement plans that are not available for all employees and because of that, they are usually not in compliance with the nondiscrimination conditions of qualified plans. Thus, these plans are labeled “nonqualified.”
What Does a Nonqualified Retirement Plan Look Like?
Nonqualified plans come in all shapes and sizes. The most common type, but not the only type, of nonqualified plan is a deferred-compensation plan.
Some employers do not contribute to a deferred compensation plan. The employee contributes to the plan through payroll deductions and doesn’t have to pay income taxes on the contributions when they are made. Later, when the employee withdraws from the plan account, the funds are taxed.
Excess Benefit Plans (EBP), Top-Hat Plans (THP) and Supplemental Executive Retirement Plans (SERP) are types of nonqualified deferred-compensation plans. These plans can be either:
There are no guarantees of the continuation or security of the plan if the employer goes out of business or if another company purchases it. Assets of the nonqualified plans do not have to be held in trust and are not protected from the employer’s creditors. This is a risk of which your client needs to be aware.
If, As and When Agreement
Some, though not many, nonqualified plans can be divided in divorce, so that your client gets their share directly from the plan. If the nonqualified plan that your client is concerned about does not allow for division in a divorce, they may be looking at an “if, as and when” agreement.
This is an agreement that identifies how the amounts will be divided after the divorce — if, as and when your client’s husband takes distributions from the plan. Your client and her husband need to agree on how the payments to your client, the nonemployee ex-spouse, will be calculated when her husband takes distributions. This is especially important if your client’s husband is several years away from retirement. It is recommended that a CPA be involved when the agreement is being negotiated. There are complications and income-tax issues to be sorted out, including the provision for income taxes that will be due at the time of distribution. Doing so will help avoid future conflicts and misunderstandings.
What Else Should Your Client Ask About?
If there is a nonqualified deferred compensation plan that does not allow for division in divorce, does your client want to wait until her husband begins distribution to obtain her share of the plan account? In that case, your client’s husband would be required to send your client their share of the distribution, after you, as the CPA, factor in the income tax calculations at the time of the divorce. The alternative is to look at other assets available in your client’s marital estate. Is there an offsetting asset that your client could get instead and receive it up-front?
Divorces highlight the need for financial literacy for the spouse who has not been involved in the family finances. This can be your opportunity to help a client get past the feeling of uncertainty about splitting the investments and fear about their financial future.
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Tracy B. Stewart, CPA, PFS, CFP, CDFA specializes in family law litigation support in Houston, Texas. She helps clients protect their wealth during property settlement negotiations. She is a member of the AICPA Personal Financial Planning and the Forensic and Valuation Services sections. Stewart is a board trustee for the Collaborative Law Institute of Texas as well as on the Executive Board of Texas Society of CPAs. You can contact her through www.texasdivorcecpa.com.
* The AICPA’s Personal Financial Planning Section is the premier provider of information, tools, advocacy and guidance for CPAs who specialize in providing estate, tax, retirement, risk management and investment planning advice to individuals and closely held entities. The Personal Financial Planning Section is open to all Regular Members, Associate Members and Non-CPA Section Associate Members of the AICPA. If you are a CPA who wants to demonstrate your expertise in this subject matter, become a Personal Financial Specialist Credential holder. Visit www.aicpa.org/PFP to learn more.