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QDROs and retirement accounts in divorce

| Apr 27, 2020 | High Asset Divorce |

When working out the terms of a divorce settlement, many couples end up agreeing to share the assets in one spouse’s 401K account as part of their property division agreement. It is important, however, that people do not assume that documenting such an agreement in their divorce decree is the only thing they need to do in order to facilitate this transaction.

As explained by the United States Department of Labor, money from an employer-sponsored retirement account may only be paid out to the person named on the account, also called the plan participant. If this person withdraws money for a purpose other than retirement, they may end up having to pay significant penalties and taxes on that amount, essentially reducing the amount they net.

When satisfying a property division award, couples may utilize a qualified domestic relations order to legally establish the plan participant’s spouse as a payee on the 401K account. This allows money to be paid directly from the retirement account to the spouse, bypassing the account holder altogether. It is then the responsibility of the spouse who receives the money to pay taxes on it. Penalties for early withdrawal would not apply due to the use of the QDRO.

The Internal Revenue Service indicates that taxes on a distribution to a spouse pursuant to a QDRO may be avoided at the time of distribution if that money is immediately rolled over into another retirement plan. A QDRO may also be established to allow an account holder to access 401K funds to satisfy a child support award. In these situations, the account holder retains tax liability.