Divorcing spouses know they must split their marital estate when their marriage ends. One asset frequently included in this process is their retirement savings.
When one partner’s 401K must be shared with the other person, a qualified domestic relations order may prevent the unnecessary loss of some of this hard-earned money.
Distributions from a 401K
Under normal circumstances, a person only withdraws money from a 401K account after retiring and reaching the age of at least 59 years and six months. The account holder may withdraw money prior to this time but may need to pay early withdrawal fees or penalties.
Even with a divorce decree in hand, a 401K account owner who withdraws funds from an account to pay a former spouse may need to pay those penalties. This further reduces the amount of retirement savings left for the account-owning spouse.
The QDRO and the authorized payee
The United States Department of Labor explains that a qualified domestic relations order allows the account owner’s spouse to be identified as an authorized payee on the 401K account. That person receives distributions from the account per the divorce decree, bypassing the account owner altogether.
The QDRO, which must be approved by the plan administrator, prevents the assessment of early withdrawal penalties.
The QDRO and income taxes
According to the Internal Revenue Service, the authorized payee assumes responsibility for income taxes on distributions received from a former spouse’s 401K account per a QDRO. However, the recipient may choose to put the money into another retirement account upon receipt. This postpones the need to pay taxes until the person takes a distribution from the new account.