Family homes and retirement accounts commonly represent a married couple’s greatest assets, making the decisions about these assets during a divorce quite important to both parties.
When it comes to splitting an employer-sponsored 401K account as part of a divorce agreement, spouses should learn about the importance of the qualified domestic relations order.
The need for a QDRO
Because 401K accounts are setup with the intention of funding retirements, distributions from these accounts for other reasons may be subject to early withdrawal penalties. These penalty fees may add up quickly and significantly reduce the amount of money a person ultimately receives.
If an account owner removes money from a 401K account and gives it to a former spouse per their divorce decree, that account owner may need to pay the penalty fees. The use of a QDRO may prevent the assessment of early withdrawal fees.
How the QDRO works
The United States Department of Labor explains that a QDRO establishes the account owner’s spouse or former spouse as an authorized payee on the account. The QDRO outlines the terms of all payments to the authorized payee and must be approved by the plan administrator. Once approved, money then flows directly to the authorized payee, bypassing the account owner altogether. Early withdrawal fees are not assessed on distributions made pursuant to a QDRO.
QDRO distributions and income tax
A person receiving funds from a 401K generally must pay income tax on the money. With a qualified domestic relations order, the account owner avoids tax assessments as the money goes directly to the authorized payee. That person may put the money into another retirement account and delay income tax payment.