When couples divorce, assets are usually divided; however, this does not automatically extend to retirement plans like 401(k)s or 403(b)s. To ensure these assets are split, you need a Qualified Domestic Relations Order (QDRO) to occur.
A QDRO is a decree, or court order, instructing the plan administrator on how to pay out the portion of a retirement plan to another person, such as a spouse or dependent. Establishing that the QDRO has been created is critical because the retirement plan administrator can NOT split your spouse’s funds without one. Furthermore, to prevent issues, it is important not to delay establishing a QDRO, signed by both parties, before your divorce is finalized. If you wait, conflicts between what the QDRO requires and what the plan can do could create disputes in getting the settled 401(k) or 403(b) funds. It is also essential that you or your spouse work with an experienced attorney well-versed in these specific types of orders to avoid any missteps.
After a QDRO is approved by both parties, attorneys, and the retirement plan administrator, 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 clients do not know that they can receive a portion of these funds directly to them without incurring the usual 10% early withdrawal penalty if they are under 59 ½. Avoiding the 10% early penalty fee is excellent 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. Although you will not be subject to the 10% early withdrawal penalty, you will still be responsible for the mandatory 20% withholding for federal taxes and maybe even state taxes.
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.
There are a few other methods for taking a distribution from your QDRO, so it is vital to speak with a financial specialist such as a Certified Divorce Financial Analyst or a CERTIFIED FINANCIAL PLANNER to understand your options and the potential tax implications fully.
Divorces are emotionally charged and complicated, and it can be challenging to keep everything organized. Bridgeworth advisor Susan Copeland holds both her CFP® and CDFA® and serves clients by applying her unique background and skillset to help divorcees work through the complexities of financial planning before, during, and after a divorce.
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