Retirement accounts are often the largest asset a person owns, so it’s no surprise that they routinely get split as part of a divorce settlement.
But under law, a retirement account is the property of the “worker” and can only be assigned to somebody else under specific conditions. In a divorce, the process of “splitting the 401(K)” is accomplished under the terms of a divorce settlement agreement approved by a state court or other authorized entity. The document that gets this done is called a qualified domestic relations order (QDRO).
Where do QDRO rules apply?
QDRO rules apply to all employer-sponsored retirement plans, like 401(k)s, pension plans, 403(b) plans and governmental 457(b) plans. Most people call them 401(k)s regardless of what they really are. If you are going through a divorce and have both a 401(k) and an IRA, you will have separate agreements for each type of account. The IRAs can be assigned to other parties with the divorce decree or a legal separation agreement.
How do QDROs work?
- A QDRO is special. You may already know that one of the benefits of a 401(K) is that it has protection under the anti-assignment and anti-alienation rules. This is the reason 401(k)s are protected from creditor and other claims. The QDRO has the power to assign all or part of a 401(k) to an alternate payee. A QDRO needs to be issued by a state authority or instrumentality with the authority to issue judgments (such as a court).
- Plan administrators reject QDROs that are not in order. As your attorney is preparing the QDRO, they will want to consult the 401(k)’s summary plan description. This will help ensure that all plan-specific requirements are met. The plan administrator is required to provide a copy of the summary plan description upon request.The plan administrator is required to notify the participant and alternate payee/s about the approval status of the QDRO. If it is rejected, the notification should include an explanation of the reason for the rejection, and the changes that must be made in order for the resubmitted QDRO to be accepted.
- Alternate payees are not just spouses. For the purpose of a QDRO, an alternate payee can include the participant’s:
- Former spouse
- Other dependent
This is different from IRAs where the assignee under the divorce decree must be the IRA owner’s spouse.
- Only a spouse may roll over QDRO amounts. You need to understand who is permitted to rollover QDRO amounts. If ineligible amounts get rolled over, they count as plan distributions and are subject to income tax and perhaps penalties.For non-spouse assignees, they will simply get a 401(k) account in their name and must follow the plan rules for distributions. Since the spouse has the rollover option, they will need to decide if they leave the money in the 401(k), roll it over to another 401(k) where they currently work, or roll it over to a self-directed IRA in their name.
- Caution: Rollover voids QDRO exception to early distribution penalty. A QDRO provides an exception to the retirement plan rule that penalizes distributions taken from a retirement account before the participant reaches age 59½. The standard is that early distributions are subject to a 10 percent early distribution penalty, unless an exception applies. One of the exceptions for 401(k) plans is distributions of amounts made under a QDRO.
Once the QDRO distribution is rolled over to an IRA the exception does not apply. And the exception does not apply if the QDRO is rolled over to a different employer 401(k) plan.
It would be wise to consider the spouse’s plans as he receives the QDRO. If they are younger than 59½ and plan to spend the money, they would be wise to make the distribution from the 401(k) under the QDRO to avoid the 10 percent penalty. They would pay income tax, but not the penalty.
It’s clear that there are complications with a QDRO. Depending on your situation and your goals, you may need some professional advice. I suggest you consider meeting with a CERTIFIED FINANCIAL PLANNER™ professional. If you meet with a planner who is always an advocate for the client – a fiduciary advisor – and only works for the client – a fee-only advisor – you can be confident that the financial advice you get is focused on your best interests and is a good fit for your complete situation.
CFP® professionals take a multi-faceted approach to your financial planning process that includes budgets, risk protection, retirement planning, investment management, taxes and estate planning. All these related aspects of your financial life are what really matter when you are trying to figure out the “smart” thing to do with your QDRO money.
As part of starting your new life after a divorce, you might want a financial road map. A CFP® professional can help you create a financial plan that is driven by your goals and priorities and addresses all aspects of your financial life.
Yes, I am a CFP® professional. I’m always a fiduciary and I only work on a fee basis. And yes, I’m still taking on a few great families to be part of my financial planning practice.
If this article has you thinking about your own circumstances, contact my office at firstname.lastname@example.org. I am always happy to meet with people who are working on their retirement plans. Dunncreek Advisors does not provide legal or tax advice, nor is this article intended to do so.