A qualified domestic relations order may allow Illinois residents to salvage some of their retirement savings from loss during a divorce.
In addition to many emotional losses and challenges, divorcing spouses in New York may also experience the loss of many financial assets. Together this is a large part of what makes getting a divorce so difficult and emotionally taxing on people. For many couples, a family home and a retirement account can be the two largest assets they own.
If the right steps are not taken, splitting a 401K account with a spouse during a divorce could mean losing more than just the amount that is paid to that spouse. The use of a qualified domestic relations order can help to prevent that from happening.
Why do I need a QDRO?
Retirement accounts are established in one person's name only even if they are ultimately deemed to be marital assets. This means that typically only the account owner is able to receive distributions from a 401K account. When a divorce settlement indicates that the non-account-owning spouse should receive a share of the funds in the account, a QDRO is needed.
The U.S. Department of Labor explains that the qualified domestic relations order allows the non-account-owning spouse to be established as an alternate payee. This means that money can be paid directly from the 401K to that spouse.
What happens if I don't use a QDRO?
Technically it is possible for a 401K owner to take a distribution from the account and then transfer that money to their former spouse. While this may meet the spirit of the divorce settlement, however, it has other consequences for the account owner.
According to the Internal Revenue Service, non-retirement distributions to a 401K account owner are subject not only to taxes but also to early withdrawal penalties. This ultimately means that the account owner would lose not only the money paid to the former spouse but a potentially sizeable portion of whatever other funds remained in the account.
When a QDRO is in effect, this does not happen. Instead, money is paid directly to the alternate payee and that person assumes all tax responsibility. By investing the money into another retirement account, immediate taxes may be avoided. Early withdrawal penalties are not assessed when a QDRO is used.
How can I set up a QDRO?
There are very specific requirements involved in creating a qualified domestic relations order. Spouses in New York should contact an attorney when they are starting divorce proceedings. This will give people access to the advice needed to ensure that a QDRO is properly prepared on their behalf.