Can a QDRO protect my 401K account?

A qualified domestic relations order may allow Illinois residents to salvage some of their retirement savings from loss during a divorce.

Anyone who has experienced a divorce in California knows that this experience can include some tough financial losses. Depending upon the details of a given divorce, it may take some people a few years to bounce back financially.

It is therefore essential that divorcing spouses make it a priority to understand the financial ramifications of every decision that is made when identifying a final divorce settlement.

When it comes to splitting the proceeds of a 401K account as part of a property division settlement, these ramifications may well include early withdrawal penalties and taxes. Knowing how to avoid losing more of one's valued savings to these fees and taxes can go a long way toward minimizing the losses from a divorce.

Understanding 401K distribution requirements

The United States Department of Labor clarifies that because the whole point of putting money into a 401K is to fund retirement, an account owner may have to pay penalties if they take funds out of an account for any reason other than retirement. This includes withdrawals made to satisfy a property division award to a former spouse even if a legal divorce decree stipulates that the other person should receive such funds.

A qualified domestic relations order, however, can avoid these penalties by establishing the former spouse as an alternate payee on an account. With this in place, money can be distributed to the former spouse directly rather than to the account owner and all early withdrawal fees may be avoided altogether.

401K distributions and taxes

Because 401K accounts are funded with pre-tax dollars, distributions from these funds are taxable. If no QDRO is in effect and an account owner received money to pay to a former spouse, that account owner may end up owing taxes on the amount received.

According to the Internal Revenue Service, when a QDRO is in effect, it is the alternate payee who must assume any liability for taxes since they are the ones who receive the money directly. If the alternate payee put the money received into another qualifying retirement account, the taxes may be avoided at that time.

Careful attention to detail is a must

The details required in order to make sure a QDRO is properly established are many. California spouses should make sure to work closely with their attorney so that all of the steps are managed appropriately and the qualified domestic relations order can be completed without error.