Are you worried about protecting your assets in a divorce? If you're in a situation where you can't agree on the division of marital assets, or if you want to make sure that your spouse doesn't get more than their fair share, a QDRO can help.
Disbursement of Marital Assets with QDRO
The trick to understanding post-divorce finances exists in knowing how your state of residency defines marital assets and property ownership within the legal confines of a marriage. A good rule of thumb is any item or fund that either partner has acquired during the marriage is considered to be owned jointly as a marital asset. Marital assets include: cars, furniture, jewelry, tools, and—you guessed it—retirement.
This means retirement funds that have accumulated during the life of the marriage are expected to be split equally between both parties through a Qualified Domestic Relations Order (QDRO). A domestic relations order is a decree that is made according to the state domestic relations and community property law—in this case, QDRO preserves the right for a former spouse to receive a fair portion of accrued retirement benefits: Premarital retirement savings is protected as a separately owned property and does not need to be split.
Community Property States such as AZ, CA, ID, LA, NV, NM, TX, WA, and WI generally require all retirement assets (401k, IRA, Pension Funds, etc.) to be split 50/50.
QDRO Disbursement Options
It’s important to remember that QDRO must be issued before the divorce papers are finalized and there are no second chances. So don’t forget to include QDRO in the divorce agreement.
- Lump-sum payment: Depending on the plan, one could opt into receiving the full amount all at once. In this case, the full amount would be transferred directly into the former spouse’s retirement account. But taxes will need to be paid if the account receiving the money is a non-IRA account.
- Penalty Free Distributions: According to the tax code, penalty free distributions are allowed before the age of 59 1/2 from qualified plans including but not limited to IRAs, 401k, Keoghs, SEPs, and money purchase pensions. The catch is that the account owner must take a fixed payment for 5 years or wait until the owner is 59 ½ (whichever period is longer). These distributions can be taken once a year or monthly until the designated period of time has been reached.
Remember that the entire time it will take someone to receive funds from QDRO could take as little as two months to as long as two years. But usually retirement funds will transfer QDRO funds into the account of the person receiving the benefit within weeks of final approval.
Illustration: Cristi Cash
What information is needed for a QDRO?
- Your spouse’s name and mailing address for the “plan participant” and your name and mailing address with you as the “alternate payee” or vice versa.
- The name of each retirement plan to be divided as terms of your divorce.
- An agreed upon percentage and how it was determined of the amount that should be paid to you.
- The planned number of payments or time period covered by the QDRO.
Tax Consequences and Retirement Payout
How someone decides to use or invest the QDRO distributions will decide how much they’re required to pay in taxes. And yes, QDRO distributions are still considered taxable income.
- Cash out: Let’s say someone gets a total of $20,000 after a divorce which was half of the 401k funds their spouse had acquired during the marriage. But instead of keeping the benefit in the account it was transferred to, the benefit receiver decides to cash out the 401(k) and use that money right away. In the event that this happens, that 401k provider will keep 20% of the payout to cover the 10% tax and the 10% early withdrawal penalty.
- IRA Transfer Incident: If someone has specified that the division of their IRA be treated as a transfer incident (no matter if the account is Roth or Traditional), then no tax will be assessed when the IRA funds are separated. Instead, the benefit receiver will have to pay the tax on any distributions they take out of the account later.
- 401k Roll Over: When someone chooses to roll their QDRO benefit into a qualified 401(k) or other account, they will be subject to pay income tax on those earnings.
Protect Your Assets
If the idea of a partner taking half or any of what you earn while married to them scares you, then it’s likely you’ll need to look into signing a prenup which is a legal document that ensures that each partner in the marriage has a right to their own individual earnings. Prenuptial agreements (prenups) are great when the goal is to protect future assets in case of divorce. Unfortunately, a prenup is an agreement that can only be made prior to marriage between soon-to-be newlyweds. But not to worry, there are other ways for married couples to protect their individual assets.
In case marriage is already a reality, one might consider entering into a postnuptial agreement which essentially protects both partners’ assets in case of a divorce. Both prenuptial and postnuptial agreements are useful even if a couple is happily married. Particularly for parents whose children have inheritances from former relationships. In that case, it’s only natural to want to keep that money safe for their children’s future needs.
All of these options are designed to protect your assets, and make sure that you get what you need from your marriage. It's possible to protect yourself even during a divorce, but it's much easier if you start planning early on.
Laws are constantly changing, so it's important to stay informed about the laws in your state and your options for protecting yourself.
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