You probably know that you will face early withdrawal penalties and taxes if you take money out of your 401(k) before you reach retirement age. You probably also know that your 401(k) account will be divided in your divorce.
If you were to write your spouse a check for half the value of your 401(k), it wouldn’t be an even split. That is because those early withdrawal penalties and taxes could cost you up to 40% of the money you take out. There is a way to avoid those penalties if the reason you’re dividing your 401(k) or 403(b) plan is a divorce.
This is done by creating a qualified domestic relations order or “QDRO.” A QDRO is a court order to your retirement plan administrator to roll a given percentage of your 401(k) or 403(b) over into another tax-advantaged account managed by a trustee, such as an IRA. Since your retirement plan administrator is making the transfer, it doesn’t count as your having withdrawn the money yourself. Therefore, no early withdrawal penalties or taxes come into being.
Likewise, your divorcing spouse doesn’t have to pay any withdrawal penalty or taxes on the money – unless they choose not to receive it into a qualifying account like an IRA. If they take the cash, they will pay a 10% penalty to the IRS and the entire amount will be treated as taxable income.
A couple of things to note
If you have already taken a loan from the retirement account you’re dividing, you will need to include special instructions. Otherwise, the amount your ex receives could be reduced by the balance of the loan.
If you have been divorced before, you may have an existing QDRO. If you do, your new QDRO can’t transfer any funds that are already promised to your previous ex-spouse.
Your attorney will draft a QDRO and present it to the court
It’s crucial that QDROs comply with federal law and the retirement account’s rules. Therefore, it’s important to have your attorney draft the QDRO and present it to a judge, who will sign it and make it a court order, assuming your ex has no objections.
It’s also important to note that not all retirement accounts are divided equally between divorcing spouses. In North Carolina, marital assets are divided equitably, not equally.
If you are considering a divorce, be sure to work with a compassionate attorney who will go the extra mile to ensure everything is done correctly.
