Many married couples save for retirement based on the expectation that they may share resources and housing in their golden years. If they divorce, they have to address any contributions made to 401(k)s and similar accounts during the marriage.
When dividing a retirement account, a qualified domestic relations order (QDRO) can help preserve as much of the account as possible.
What is a QDRO?
A QDRO is a court-approved document instructing a financial professional to divide a retirement account. People use QDROs for 401(k)s and even pension accounts. If the terms of the property division order require the direct division of the account, a QDRO helps preserve as much of the account balance as possible for the spouses.
Pre-retirement withdrawals from tax-deferred retirement accounts usually result in penalties and tax consequences. The party making the premature withdrawal has to pay 10% of the amount they withdraw as a penalty.
They must also report the amount withdrawn as income. Splitting an account during retirement could add tens of thousands of dollars in taxable income for the year without a QDRO. If the spouses use a QDRO drafted by a lawyer, signed by both spouses and approved by the courts, they can avoid the 10% penalty and income tax consequences of an early withdrawal.
The professional managing the account moves a specific portion of the original account balance into a new account in the other spouse’s name. As long as they do not withdraw those funds, they do not have to report or worry about a penalty.
Drafting a QDRO can help people preserve their retirement resources. A QDRO is an important tool if spouses agree to divide retirement funds instead of using other assets to offset their value during the property division process.
