Splitting assets during a divorce can be an arduous task. To complicate things, the division of certain retirement savings accounts requires an extra step.
DRO vs. QDRO
Divorce proceedings often conclude with a domestic relations order (DRO) to lay out the division of retirement assets. Assets from a qualified retirement plan, such as a 401(k), are covered by the Employee Retirement Income Security Act of 1974 (ERISA). These types of retirement plans have strict rules when it comes to benefit distribution and therefore they require an approved DRO is known as a Qualified Domestic Relations Order (QDRO).
Federal law stipulates that a QDRO is required for qualified plans like defined benefit plans, ESOPs, 401(k) plans, and profit-sharing plans. According to ERISA and Internal Revenue Code, most qualified retirement plans won’t pay any benefits to an ex-spouse without a QDRO because plan participants can’t legally assign their stake in the plan to someone else. Therefore, the QDRO is used to distribute benefits to an alternative payee.
When a QDRO isn’t Needed
Non-qualified plans, such as Individual retirement accounts (IRA’s) are not covered by ERISA. This generally exempts them from the requirement of a QDRO to divide assets, however, the administrator sometimes still requires some type of DRO to divide the plan. Sometimes during divorce settlement negotiations, one spouse may propose trading another asset in place of a share in a retirement account. This may often eliminate the need for a QDRO.
Division of Assets
While a QDRO may require a participant to pay out a portion of funds, the court will generally divide only the marital amount of these benefits. This means contributions made and associated growth from the date of marital separation may not qualify as divisible funds.
The participant is the retirement plan owner, and while it may seem like a QDRO primarily benefits the alternate payee, the participant can benefit as well.
Federal law imposes a 10% penalty on withdrawals taken by individuals prior to age 59.5. However, transfers made according to a QDRO are not subject to early withdrawal penalties, because they are not considered a withdrawal. You are simply dividing one plan into two plans and the total amount of the monies in the plan remains the same.
However, if you then take a distribution, or early withdrawal, from your portion of the plan, that distribution will be treated as income and therefore will taxable. The person who takes the distribution, whether they are the participant or alternate payee, will be responsible for the tax.
If you are entitled to an ex-spouse’s qualified retirement plan according to a divorce decree, a QDRO is required for the retirement plan administrator to divide the plan assets.
If you have questions about your pending or finalized divorce assets, contact our office. We can help you determine if a QDRO is needed as well as help draft your QDRO form.