Getting divorced is never easy. Dividing assets is not fun. And, one of the largest assets many married couples have is their 401(k)—which can be tricky to divide because the rules for doing so are complex. The division of these retirement funds in a divorce (including all employer-sponsored retirement plans) requires a qualified domestic relations order (QDRO). QDROs also apply to pension plans, 403(b) plans, and governmental 457(b) plans. So, if you’re getting a divorce and facing having to split the funds in any of these types of accounts, read on…
The process for dividing and/or reassigning assets to a former spouse within a typical IRA account easily be spelled out in a domestic relations order (DRO), which is included in your divorce settlement and approved by a state court or other qualified entity. But, one of the greatest benefits of 401(k)s are the fact that they receive protection from creditors and other potential claims thanks to anti-assignment and anti-alienation rules. However, in the case of divorce—there is an exception to those rules that allows all or a portion of the funds to be assigned to another payee.
Simply put, a QDRO is a qualified domestic relations order that fulfills precise requirements of the retirement plan’s administrator. This qualified order allows the bypassing of the anti-assignment rule that would otherwise protect the funds in the 401(k) from reassignment to another payee.
It is critical that you consult with your attorney to ensure your QDRO is correctly written. These professionals take care of the details and fine print required to distribute your 401(k) funds accordingly.
And here’s why…
Only a spouse can choose to rollover his or her entitled funds into another IRA or 401(k). But, in order to do so, the spouse must be designated in the QDRO as the alternate payee. Note: there are complex exceptions to early withdrawals of rollover funds. Those who are designated an alternate payee of 401(k) funds in a divorce should consult an advisor to ensure any move made in the rollover account does not incur the 10% early-withdrawal penalty or cause unexpected taxation.
Alternate payees of those qualified 401(k) reassigned funds do not have to be an ex-spouse. Alternate payees can include children and/or any other dependent that is included in the domestic relations order/divorce decree.
Alternate payees receiving any distribution of the QDRO amount are required to report the amount they receive as income, and they will be taxed on the distribution. But, as the distributions fall under a QDRO, these payees are not subject to the 10% early withdrawal penalty. distribution penalty (see below), even if they are taxable.
The rules outlined in this article are the basics of dividing your 401(k) funds during a divorce. This article is not to be interpreted as financial or legal advice, but to give you an idea of just how complicated reassignments of 401(k)s and other qualified plans can be during a divorce. You must consult appropriate, trusted, and qualified advisors or CPAs who are well-versed in these transactions to ensure yours is properly executed.