What happens to retirement accounts during divorce?
When couples go through a divorce, the division of their retirement accounts may become a matter of concern. These accounts are often substantial and can significantly impact the property division process.
Two key concepts that often come into play when division of retirement accounts are at issue are the transfer incident to divorce and the qualified domestic relations order (QDRO).
Transfer incident to divorce
Transfer incident to divorce refers to the tax-free transfer of retirement account assets between spouses as a part of divorce proceedings. Under the U.S. tax code, when a portion of a retirement account is transferred to a spouse or former spouse as part of a divorce decree, the recipient typically doesn’t have to pay income tax on this transfer. It’s essential to ensure that the transfer is directly related to the divorce and is detailed in the divorce agreement or decree to avoid unintended tax consequences.
Qualified domestic relations order
A QDRO is a legal document typically used in divorces to divide assets in employer-sponsored retirement plans, such as 401(k)s and pension plans. It is a court order that recognizes the right of a spouse, former spouse, child or other dependents to receive a predetermined portion of the account holder’s retirement plan.
The QDRO must contain specific information, including the amount or percentage of the plan’s benefits to be paid to the alternate payee, which is the spouse who is receiving the portion of the retirement benefits, and how this amount will be determined. The court and the retirement plan’s administrator must approve the order.
One critical element of QDROs is that they can allow the receiving spouse to access funds without the early withdrawal penalties that typically apply to individuals younger than 59½. However, regular income tax may still apply to distributions.
Both of these methods require careful adherence to legal and tax regulations to ensure that the division is carried out correctly and to avoid unnecessary taxes and penalties. It’s a good idea for individuals going through a divorce to seek legal guidance accordingly.
