Do I need a qualified domestic relations order?
When getting a divorce, Arizona spouses may agree to split one party’s 401K account as part of their property division settlement. The use of a qualified domestic relations order may help avoid the need to pay high fees associated with this.
For most people in Arizona who get divorced, the losses associated with this life event can feel substantial. These may include not only the loss of a partner but of a home, shared friends, time with one’s children and significant financial assets.
When it comes time to split a marital estate, retirement savings may be one of the assets to be shared by both parties. Managing this requires a good understanding of these accounts and the rules that govern them.
401K accounts and distributions
As the name implies, a retirement account is established with the purpose of funding the account owner’s retirement when the time comes. Employer-sponsored 401K accounts are funded with pretax dollars, meaning that income tax assessment occurs at the time of distribution rather than before being invested.
Any distribution from a 401K account for a reason other than retirement may be subject to early withdrawal penalties on top of the income tax assessment. Together, these assessments may take a significant bite out of a person’s hard-earned savings. This understandably may make a person highly resistant to splitting an account with a spouse during a divorce.
Retirement accounts and property division settlements
If the owner of a 401K account took money from the fund to pay a former spouse as per their divorce decree, the account owner may need to pay the early withdrawal penalties and taxes. However, the use of a qualified domestic relations order may prevent this situation.
A QDRO enables the former spouse to be named as an alternate payee on the 401K account. Funds may therefore be distributed directly to that person, bypassing the account owner altogether. No early withdrawal penalty is assessed when a qualified domestic relations order is in effect.
A qualified domestic relations order must be reviewed and approved by the plan administrator as well as the judge. Details on the order should include how much money should be paid. This may be a set dollar amount or a percentage of the fund’s value. Payments may be one-time or multiple.
A QDRO may also be established to allow the account owner access to the money to satisfy a child support order. In this event, the child or a legal guardian may be named as the alternate payee.
QDROs and taxes
When a QDRO is used as part of a property division settlement, taxation liability for the disbursements lands with the recipient. When a QDRO is used to satisfy a child support order, taxation liability remains with the account owner.
Legal input matters when splitting 401K accounts
Many fine details must be adhered to when splitting a 401K account during a divorce. Arizona residents facing this situation should consult with an experienced family law and divorce attorney to guide them through the process.