You probably already know that employers are required to honor qualified domestic relations orders (commonly referred to as “QDROs”) regarding the division of qualified retirement plan benefits (such as 401(k) balances) when an employee gets divorced. However, many employers mistakenly assume that they must also honor domestic relations orders (“DROs”) related to nonqualified retirement plans when, in fact, they do not have such an obligation.

Why don’t we have to honor DROs related to nonqualified retirement plans?

As a refresher, nonqualified retirement plans that are considered “top-hat plans” under ERISA are exempt from most aspects of ERISA, including the requirement that employers honor QDROS. Yet, top-hat plans are subject to the provisions of ERISA which include ERISA’s broad preemption of state law. This leaves top-hat plans in a unique position – they are not bound by ERISA’s QDRO provisions, but arguably they are also not subject to state law regarding the division of marital assets. As such, employers have discretion to decide whether to honor or not honor DROs that assign some or all of a participant’s nonqualified plan benefits to an ex-spouse.

Can we honor DROs if we want to?

Employers will need to check the terms of the each of their nonqualified plans to determine if they can honor DROs under each plan. But don’t expect to necessarily find a clause that specifically addresses DROs. Instead, many nonqualified plans will include an anti-assignment clause that prohibits the plan participant from assigning his or her benefits to anyone else. If your plan includes this language without an exception for DROs, then you generally could not honor a DRO unless you first amended the plan.

In contrast, if the plan does not prohibit the assignment of benefits, then you generally have the discretion to honor DROs if you choose to, as long as you follow the terms of your plan. You can even accelerate payments to the ex-spouse under a plan that is subject to Internal Revenue Code Section 409A, as there is a specific exemption to the general anti-acceleration rule for payments made pursuant to DROs.

Should we honor DROs?

The answer to this question requires employers to balance their own interests with the interests of their employees. On the one hand, nonqualified retirement plan benefits may represent a significant portion of an employee’s wealth, and without access to these funds in a divorce, an employee will need to rely on other assets to satisfy obligations to their former spouse, such as assigning to their ex-spouse grandpa’s stamp collection or the family vacation home.

On the other hand, honoring a DRO can be expensive for employers. Most nonqualified retirement account balances are just bookkeeping entries that are paid directly from the company’s general assets when due. So, honoring a DRO that requires an immediate lump sum payment could require large cash outlays under the plan sooner than expected. Alternatively, if the DRO requires payment to the ex-spouse only as and when the payments would otherwise be due to the employee, employers will need to address the administrative challenges in tracking what portion of the benefit belongs to the employee versus the employee’s ex-spouse.

What should we do now?

The big takeaway for employers is this: Decide now whether or not you want to honor DROs for nonqualified plan benefits, and then make sure your plan clearly articulates your intent. The worst thing you could do is nothing — you don’t want to find yourself having to make a judgment call based on ambiguous plan terms while you’re seated across the table from an emotional employee in the midst of a divorce.