Outstanding loan balances from defined contribution plans (e.g., 401k) should be specifically addressed in the Judgment of Divorce or Legal Separation [JOD for short]. The plan will not divide, or assign part of the loan obligation to the non-employee. Only the employee can be responsible to pay the loan per plan terms. (The JOD of course can obligate the non-employee to contribute towards the loan payments, as with any other loan).
Stating a plan division is “inclusive of loan”, or a similar provision in the JOD means, that not only is the current plan owner solely responsible to repay the loan on that party’s retirement plan, but the loan balance is added back to the total account balance and then divided. As such, the separated accounts are “equalized” with the loan balance included in the employee’s separate balance only.
Or, it may be stated in the JOD - Party A shall be responsible for the retirement loan. That could be interpreted as meaning, Party A is not only responsible for repayment, but also that the loan balance is to be included in the balance divided. Be certain that is the intent, as the employee repays a 401(k) loan to him/herself, including the interest (their plan account), not a third party.* Thus, they may be willing to repay the loan, but would have a very different outlook on the loan amount being included in the plan balance being divided, since it only benefits the other party.
For example, if the plan has an original balance of $50,000, and a $10,000 loan is taken. “Including” the loan in the plan division means, $50,000 is divided, and with a 50/50 split, the non-employee gets $25,000, the employee gets $15,000, as understandably, the plan will only divide “net” or non-loan assets in the plan. [*IRAs do not permit loans. Plans other than 401(k) may permit loans, but the interest on the loan may be paid to a third party, not the Participant’s account].
Combining Plan Division (or dividing several plans through one plan)
It is not uncommon to equalize several retirement savings plans through one DRO dividing one plan, with the amount of division adjusted for the value of the other plans. If doing so, it must be understood only the plan being divided by the DRO will reflect market gains/losses from the division date in the transfer amount. Therefore, the DRO should be filed as soon as possible after the division date, as the other accounts will also change in value.
The presumption to this division may be, the value of all plans will generally move in the same direction, i.e., increase or decrease per market conditions, but of course the amounts may vary from plan to plan, or not move in unison at all. For example, bond funds are generally more stable than stock funds, and even increase in value when stock prices decrease.
If this type of division is involved, the parties may consider moving their funds in the plan(s) not divided by a DRO, into an investment not subject to market fluctuation, until the transfer is complete; for example, a money market account. This has the downside the plan will miss any general market gains that may occur, but isolates the plan(s) from market losses. If using this method, the parties should make sure the transfer will not be considered a taxable event. If the transfer is within investments in the same retirement plan, it should not be taxable event.
We reserve the option of charging an additional fee for evaluating and documenting the division of several plans through one order dividing one plan. While the concept of using one order may appear simple, it often does not materialize that way. Plan statements must be compiled, carefully reviewed, balances documented, and only then is the transfer amount computed and communicated to the parties for their agreement. This always generates more communication, including reminders, questions, explanations, etc. If an additional fee is anticipated, the parties will be informed in advance, and it will be assessed on time spent, so the parties can control the amount. Cooperation, reasonableness, and promptness will be less costly than lack thereof.