When going through a divorce, spouses must identify how they will split any shared assets. Even though a retirement account is held in one person’s name, it may well be deemed a marital asset and therefore be subject to split in a divorce.
Outlining the terms of a 401K split in a divorce decree may not protect the account owner from losing some of their savings to early withdrawal penalties. The use of a qualified domestic relations order, however, may.
The alternate payee
Typically, disbursements from a 401K account may be made only to the account owner. If the owner withdraws funds and provides those to a former spouse to satisfy a property division settlement, the owner may be assessed high early withdrawal fees as the transaction does not meet retirement criteria. In addition, the account owner may need to pay income taxes on the amount taken out.
As explained by the United States Department of Labor, a qualified domestic relations order establishes the former spouse as an alternate payee on the 401K account. The alternate payee may receive disbursements directly from the account, bypassing the owner and avoiding the assessment of early withdrawal fees.
The administrator of the 401K plan must review and approve all terms of the QDRO, including detailed accounting of what amount or percent of a fund’s value shall be paid to the former spouse.
Income tax assessment
By using a QDRO, income taxes on money withdrawn from a 401K account become the responsibility of the recipient, not the account owner. According to the Internal Revenue Service, if funds are put into another retirement account, taxes may be deferred.