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. However, 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 stricter rules when it comes to benefit distribution and therefore 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 (IRAs) are not covered by ERISA. This exempts them from the requirement of a QDRO to divide assets. Additionally, during divorce settlement negotiations, one spouse may propose trading another asset in place of a share in a retirement account which would eliminate the need for a QDRO.
Division of Assets
The division of assets under a QDRO must abide by state law and consider child support, alimony, or other marital property rights.
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, withdrawals made according to a QDRO are not subject to early withdrawal penalties.
Benefits distributed from a retirement plan under a QDRO are treated as income and are therefore taxable to the participant. When funds are sent to an ex-spouse, the funds become part of their income meaning the ex-spouse and not the participant will be responsible for the tax.
If you are entitled to an asset of 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.