You and your soon-to-be ex-spouse have both saved and invested for the long-term within retirement plans, accumulating sizable nest eggs. But what is going to happen if you should become divorced? Will will own the assets and how?
In a divorce, the former spouse and dependents may be entitled to a portion of the retirement assets as part of the divorce settlement. If this is the case, the settlement may include what’s know as a qualified domestic relations order (QDRO). This order outlined by the IRS code that defines the what, when, and how the division of 401(k) or other retirement plan assets will occur. It is a court judgment or order that names someone other than you as the recipient or owner of the retirement assets. This other person or recipient is known as the alternate payee and may be your spouse, your child, or another dependent.
The benefit to using a QDRO as part of the settlement is that the money moved from the retirement account is not subject to the 10 percent early withdrawal tax penalty, even if you and your alternate payee are both younger than age 59 1/2. But take warning, if the QDRO is not properly executed on, you will be subject to that early withdrawal tax penalty. In the midst of divorce and the distribution of these assets to other parties, the last thing you want to face is a tax on money that is no longer yours.
Ensuring the Validity of a QDRO
In order for a QDRO to be valid, it must meet some legal requirements. It must be correctly created and it must be adequately verified. Checking the status of your QDRO at both stages is wise to ensure that your QDRO is acceptable under the law. If this seems like a lot of trouble, keep in mind that aside from preventing undo taxation, the other reason why such checking and double-checking takes place is to prevent someone from illegally accessing your retirement assets.
Creation of the QDRO
To be considered a QDRO, the division of your assets must first and foremost be directed by a court order issued in compliance with state laws. The IRS code states that the QDRO must include the following information to be valid:
Verification of the QDRO
If your 401(k) plan assets are subject to a QDRO, you must provide your plan administrator with either the original court order or a court-certified copy of your QDRO document. Your plan administrator will then follow formal procedures to establish the legality of the QDRO and put it into motion. These procedures are part of the rules set down in your 401(k) summary plan description (SPD), and by law they must include:
A QDRO Case Study
In a famous case, a man paid out $1 million dollars from his retirement plan as part of his divorce settlement. The man assumed that the order was a QDRO, but missed several key elements that caused the order to be invalid. First, the man’s former wife was not identified as the alternate payee. Second, the order did not include the name or address of the alternate payee. Third, the man did not follow proper procedure for verifying the order.
Because the man was the administrator of the retirement plan in question, he argued that he did not need to file forms with himself, and that the order did not need to include the name and address of the alternate payee because he was personally aware of the details. The IRS did not agree, and deemed the settlement payment an early distribution, subject to the 10 percent early withdrawal federal income tax penalty. This error cost him $100,000.
The Division of Funds in a Divorce
How your funds are divided relies in part on the state in which you live. In most states, your assets are subject to equitable distribution during a divorce settlement. This means that 401(k) assets accumulated during your marriage probably, but not necessarily, will be divided 50-50. Other factors, such as the division of the rest of your marital assets, the length of your marriage, or what each of you contributed to the marriage will also play a part in the decision. However, if you live in a state with a community property law, you may face an equal split in your 401(k) assets regardless of the other division of marital assets. Following is a list of states that presently include the community property law:
What to Do with QDRO Assets
If you have recently gone through a divorce and will receive money from your former spouse’s 401(k) plan, you have options.
This legal issues surrounding the use of and the execution of a Qualified Domestic Relations Order are numerous and far-reaching. You will find great value when your attorney works with an employee benefit plans specialist in the drafting and execution of the QDRO agreement. This is the first step in planning your financial future, make it a good one!
For more information contact Compass Asset Management Group, LLC at 845.563.0537 or Contact@CompassAMG.com
The information herein contained does not constitute tax or legal advice. Any final decisions or actions should not be made without first consulting a CPA, Accountant or attorney.
The author of this blog, Steven M DiGregorio is President of Compass Asset Management Group, LLC and an Investment Advisor Representative with Spire Wealth Management, LLC a Federally Registered Investment Advisory Firm. Securities offered through an affiliated company Spire Securities, LLC a Registered Broker/Dealer and member FINRA/SIPC.