Benefits of a QDRO

A Qualified Domestic Relations Order can be an essential means by which divorcing spouses can split 401K accounts and avoid high taxes and penalties.

For many couples in Massachusetts, a 401K account can be one of their most significant financial assets in addition to a family home. Therefore, when getting divorced, it is understandable that spouses often end up splitting these retirement accounts as part of their property division settlements.

However, simply outlining the division of a 401K account in a divorce decree is not enough. Relying on this alone could end up in one or both spouses having to pay high penalties and taxes. The use of a Qualified Domestic Relations Order is required in order to avoid this from happening.

How are retirement distributions handled?

As noted in the name, retirement accounts are intended to provide income for people during retirement. Therefore, under most circumstances, any distribution taken from these accounts prior to that time may be subject to early withdrawal penalties as well as income tax. These penalties and taxes can dramatically reduce the amount of money that a person ultimately receives.

How does a QDRO help?

As explained by the U.S. Department of Labor, a Qualified Domestic Relations Order may help people to avoid paying the taxes and penalties associated with receiving money from a 401K prior to reaching retirement age.

The QDRO works by first establishing a person other than the plan owner as an alternate payee on the account. For the purposes of a property division settlement, this would be the other spouse. It also outlines the amount of money or percentage of account value to be transferred to that alternate payee and identifies the distribution as pursuant to a divorce.

It is important for spouses receiving money from their former partner's 401K to know that the mere existence of a QDRO does not alone prevent taxes and penalties from being assessed. Smart Asset explains that money received must be reinvested into a qualifying retirement account in order to avoid the taxes and penalties.

Recipient spouses may also choose to defer payment until the plan owner retires. However, such distributions must take place before the alternate payee reaches the age of 70 years and six months.

What else should I know about splitting a retirement account?

Not every type of account requires a QDRO. Some, for example, require what is called a transfer incident to divorce. Working closely with an attorney during a divorce is highly recommended. This will help Massachusetts residents learn what documents and processes are required to appropriately protect assets and avoid losing out on important benefits.