Divorce Finances: Taxes, QDROs, & Retirement Divisions
Generally speaking, upsetting a retirement account before it is permissible to do so can result in a major tax penalty. However, when couples divorce dividing retirement accounts is inevitable. If the retirement account is a qualified employ plan, such as a 401K or pension that receives contributions from the employer, a tax free division can take place through the use of a Qualified Domestic Relations Order (QDRO).
A QDRO, simply put, is a legal instrument that allows for a person to assign rights in a retirement account to another person and allows people to avoid paying any retirement taxes. This order will allow the account to be separated and withdrawn with no tax penalty, so long as the funds are deposited in another retirement account. The order itself will be sent to the plan administrator after it is signed by a judge, and it will instruct the administrator as to how the funds are to be dispersed.
You will want to draft everything in your separation agreement. Once you’ve completed with your separation agreement or court order, you’ll then have a QDRO or other domestic relations order drafted following the guidelines laid out in your agreement or order.
However, keep in mind that it is not sufficient for your separation agreement or divorce decree to state that you are entitled to a portion of your spouse’s retirement. The administrator of the plan will not pay your share to you without a QDRO which is signed by a judge.
You will need to provide the latest account statement from the qualified retirement account as well as the plan language provided by the plan. Each plan will have a different exact language required by the plan administrator. However, as long as you follow the requirements of the plan administrator, you should be able to avoid paying any retirement taxes with the division of your spouse’s retirement accounts.