Dividing assets is one of the most common causes of conflict during a divorce. Retirement accounts are often among the most substantial assets to be divided, but the regulations surrounding how this is done can be complex and require the use of a very specific procedure: a Qualified Domestic Relations Order or QDRO.
What is a Qualified Domestic Relations Order?
A QDRO is an order handed down by a judge that specifies how qualified retirement plans will be split once the divorce has been finalized. However, Qualified Domestic Relations Orders are not applicable to all retirement accounts. Only employer-sponsored retirement accounts covered by the Employee Retirement Income Security Act will be subject to Qualified Domestic Relations Orders. Pensions and 401k plans are two of the most common examples of qualifying retirement plans. After the QDRO has taken effect, ex-spouses are able to choose between receiving a lump sum payment or smaller installments.
What are the advantages of a QDRO?
Qualified Domestic Relations Orders can help streamline the division of retirement assets and limit potential conflicts and issues as well. Typically, there will be a penalty for removing assets from a 401k if the plan holder is younger than 59 ½ years old. However, after a QDRO has been put in place, the ex-spouse receiving the assets will not be subject to any tax penalties so long as they immediately transfer the funds into another retirement account.
The disadvantages of QDROs
In the state of New York, retirement plans are considered marital property. But, any assets or contributions placed into the account prior to your marriage, will be deemed separate property and will not be subject to division. This can significantly limit the funds that are divided during the marriage.
Another aspect of Qualified Domestic Relations Orders to be aware of is that the recipient could face income tax penalties if they choose to directly receive the funds instead of transferring them into their own retirement account. Furthermore, if the recipient decides to inherit the 401k funds directly, they could also face an additional tax penalty of 10% if they are under 59 and a half years old.
Making the decision to file for divorce can be difficult at any age. But if you have a retirement plan or are nearing retirement age, this process can be even more challenging. Fortunately, with the help of a Qualified Domestic Relations Order, divorcing spouses can divide their retirement assets in a clear-cut way and avoid unnecessary conflicts.