Qualified Domestic Relations Order (QDRO)
If a couple has a joint investment in a retirement plan, such as a 401(k) or IRA, and subsequently divorces, the plan can be divided to give each spouse their fair share. To take this advice without either spouse incurring a massive penalty for early withdrawal from the account, the couple will need to initiate a Qualified Domestic Relations Order (QDRO).
A QDRO allows ownership in the plan to be transferred to an alternate payee, such as a former spouse or dependent child. Through a QDRO, property can be divided and alimony payments can be made. A QDRO is basically a legal order, due to a divorce or separation, that splits ownership of a retirement plan in order to give each ex-spouse a fair share of the plan or assets.
If you are going through a divorce it is important to seek professional advice if you will be affected by a Qualified Domestic Relations Order. Along with this, there are tax implications that you also need to be aware of. The more advice you receive about divorce and QDROs, and how they will change your tax situation, the better off you are going to be.
When receiving divorce advice from a professional, make sure you ask about a QDRO and whether or not it will come into play. To be “Qualified” for this option, the plan must be a recognized pension or benefit plan under the Employee Retirement Income Security Act (ERISA). After you bring your QDRO proposal to your state domestic relations court, the administrator of your plan will make sure that it complies with the ERISA.
With most QDROs, the person known as the alternate payee (not the primary holder) is taxed when the funds are withdrawn from the account. It is important to note that the 10% early distribution penalty does not apply here. If the spouse who receives part of the other spouse’s plan completes an IRA rollover within a 60-day window, tax on it can be deferred. This is notable divorce advice because it means you can take funds from the plan and roll them into an individual retirement account (IRA) without being taxed.
However, before you act on this advice, note that this is only the case if you are a spouse ― not a dependent. Also note that the rollover must happen within 60 days of receipt of the funds from the QDRO. To ensure that you avoid the standard 20% federal income tax withholding, make sure the funds are directly transferred from the qualified plan to your IRA.
Also consider this divorce advice: The fund is rather easily divided if the participating spouse signed on with the plan after the commencement of the marriage ― approximately half of the plan’s value (as of the date of divorce) is awarded to each spouse. If the spouse was part of the plan before the marriage, the plan is often distributed by dividing the duration of plan participation by the duration in which the spouse was both married and a member of the plan.
If you want to take full advantage of the tax advice above it is recommended that you use a QDRO to split up any qualified retirement plans. Neglecting to do so could result in hefty penalties and tax charges. It is also important to get professional advice to will help you obtain the assets you deserve. To get proper divorce advice, you may want to hire a tax attorney. Your tax professional or certified public accountant (CPA) may be also familiar with QDROs as well.
If you are going through a divorce and a Qualified Domestic Relations Order is in your future, make sure to seek advice from a qualified professional. This will help to ensure that your assets are divided fairly and you do not incur any unnecessary taxes.