Getting divorced and dividing up assets is no easy matter. At least you can sell a house, a car or certain other possessions and distribute the proceeds to the two ex-spouses according to ownership rights under the law. But liquidating other types of property, such as assets in a qualified retirement plan, can be more complicated.
Using a qualified domestic relations order (QDRO) may provide for the transfer of assets in a qualified retirement plan to a nonparticipant spouse without incurring dire tax consequences. This can help you preserve more of your retirement account savings for your estate.
How a QDRO works
A QDRO provides a relatively straightforward means of accommodating a transfer of qualified retirement plan assets. A court with jurisdiction or another appropriate authority issues the QDRO. Essentially, the QDRO establishes that one spouse has a claim to some of the other spouse’s retirement plan accounts.
Typically, the QDRO will state either a dollar amount or a percentage of assets that belongs to the spouse of the participant, called the “alternate payee” in legal parlance. It also specifies the number of payments to be made (or the length of time for which the terms apply).
A QDRO may be used for qualified plans covered by the Employee Retirement Income Security Act (ERISA), including 401(k) plans, traditional pension plans and various other plans. In contrast, IRA funds, which aren’t covered by ERISA, generally are disbursed according to the terms of the divorce agreement.
With an approved QDRO in place, the alternate payee doesn’t owe any penalty tax on distributions. Thus, you can arrange a lump-sum distribution or series of periodic payments penalty-free according to the order, regardless of your age.
A QDRO must provide certain information. This includes the names and addresses of both the plan participant and the alternate payee; the dollar amount or percentage of assets being transferred to the alternate payee; and other vital details such as the amount, form and frequency of payments. If required information is omitted, a judge won’t sign off on the order. Rely on your legal and financial advisors to ensure that all formalities are met.
After a QDRO is approved by the judge, there’s still more work to do. The alternate payee must submit it to the administrator of the retirement plan. Every plan governed by ERISA must follow the authorized process for QDRO filings.
Available payment options
Assuming QDROs are allowed by the plan, the alternate payee will have payment options to consider. For starters, he or she can take a lump-sum distribution of the full amount. However, this may result in a higher overall tax liability than if the payments were spread out. Or, the alternate payee can arrange to receive regular payments just like the plan participant, thereby reducing the total tax hit.
Another option is to roll over the assets into another plan or IRA. If the usual requirements are met — for example, the rollover is completed within 60 days — no current tax is owed for the year of the transfer.
Finally, the alternate payee may leave the money where it is. If permitted by the plan, additional contributions to the account may be made in the future.
Contact us for additional guidance.
