How a Qualified Domestic Relations Order Relates to your Spouse’s (or soon to be Ex-Spouse’s) 401(k)
When couples divorce, they usually divide their assets; however, this does not automatically extend to retirement plans like 401(k)s or 403(b)s. To split these assets, you need a Qualified Domestic Relations Order (QDRO).
A QDRO is a decree, or court order, instructing the plan administrator how to pay a portion of a retirement plan account to another person, such as a spouse or dependent. Creating the QDRO is critical because the retirement plan administrator cannot split your or your spouse’s funds without one. Further, it’s important to establish a QDRO, signed by both parties, before your divorce becomes final. If you wait, conflicts between what the QDRO requires and what the plan can do could create delays in getting the settled 401(k) or 403(b) funds. You or your spouse should consider working with an experienced attorney well-versed in these specific types of orders to avoid any missteps.
After both spouses approve a QDRO, attorneys, the retirement plan administrator, and the spouses will sign and present it to the family court judge for final signature. Once the judge finalizes everything, this signed document is ready for submission to the retirement plan administrator. The custodian who holds the 401(k) funds will then split the assets according to the order’s instructions.
After receiving funds through a QDRO, many individuals do not know that they can receive a portion of these funds directly without incurring the usual 10% early withdrawal penalty if they are under age 59 ½, although they will still be responsible for the mandatory 20% withholding for federal taxes, and any state taxes that may apply. Avoiding the 10% early penalty fee is welcome news, especially if you would like to use a portion of the funds to buy a home or pay your attorney fees. Keep in mind this is a one-time withdrawal; if you decide you want to move excess funds later, you will be required to pay the 10% early withdrawal penalty fee.
Since the qualified plan assets you receive under a QDRO are rollover-eligible, amounts paid directly to you instead of to an eligible retirement plan are subject to mandatory withholding. This withholding is 20% for federal taxes and an additional charge for state taxes, depending on where you live. Therefore, you may want to ask for an increase in the distribution amount to ensure the net amount you receive is enough to cover these plus expenses.
A few other methods exist for taking a distribution from your QDRO. Consider speaking with a financial specialist such as a Certified Divorce Financial Analyst or a CERTIFIED FINANCIAL PLANNERTM professional to better understand your options and the potential tax implications.
At Savant, we work with clients before, during, and after divorces. If you need help with a QDRO or any other financial planning issues related to divorce, we’re here to help. Schedule a no-obligation, introductory call to learn more.
This is intended for informational purposes only. You should not assume that any discussion or information contained in this document serves as the receipt of, or as a substitute for, personalized investment advice from Savant. Please consult your investment professional regarding your unique situation.