A 401(k) is a common asset that has to be divided in a divorce. In many cases, the 401(k) is one of the more valuable assets. Individuals often work their whole career trying to build up their 401(k) balance so that they can retire.
However, in a divorce, the 401(k) often ends up divided as part of the property division process. In some cases, the 401(k) does not need to be divided. It could be the 401(k) is offset against other marital assets. In other cases, the 401(k) is divided because it is the only means to fairly distributed marital property and debt.
To divide a 401(k), a Qualified Domestic Relations Order (QDRO) is necessary. A court issues a QDRO. There are three steps in splitting a 401(k) during a divorce:
- The court will order the divorce to take place in the divorce decree.
- Drawing up a QDRO, which describes to the plan administrator how to split to remain compliant with the Employee Retirement Income Security Act.
- The judge and the plan administrator will sign the QDRO naming the receiving spouse as the alternate payee.
The QDRO must contain the name and contact information of the plan participant and receiving spouse. There should also be a timeline for the payout. If multiple payments will take place, an outline of those payments is necessary.
Splitting a 401(k) with your spouse
To understand the divorce impactions of splitting a 401(k), it is important to know the options as a separated couple. If the court orders half the 401(k) to go to the spouse, it is likely that they will want to roll the funds over into their own retirement account. If the spouse decides to leave the funds in the account until retirement, they will avoid paying taxes until then.
The other choice is to simply cash out half that is owed to the other party. Under the Internal Revenue Service Code, if the cash-out is part of a QDRO, it will not be subject to the 10 percent penalty. For the receiving spouse, this is a great way to take the benefits now as opposed to rolling them over. There will be income tax consequences for doing this.
An important thing to consider is that if one is considering a cash-out option it is a one-time deal. A person will need to act quickly if the money is something a person wants. Unless that person is over 59.5, there will be a 10% penalty if they decide later to cash out. Even if there is a QDRO that has been issued, it is important to do things efficiently.
Avoiding penalties when splitting a 401(k)
For a 401(k) withdrawal due to divorce to take place without penalties, the spouse that holds the 401(k) has the responsibility to submit it to the plan administrator. The plan administrator should get back to the parties promptly. It is important to note that if significant time passes, a follow-up is often important. If a QDRO is in place, it is an alternative payee’s right to contact the administrator to ask about their spouse’s benefits. The laws under the Department of Labor give an alternative payee a right to said information.
Getting QDROs pre-approved by the plan administrator before the parties signing can be vitally important. This can ensure the plan administrator does not reject a QDRO after they have signed it. Further, the parties should sign the QDROs as well. Some QDRO forms just have the lawyers signing the QDRO by default, but most parties do not want their lawyer to move their money without consent. Additionally, parties should not forget that a judge also has to sign a QDRO before submission to the plan administrator. Most plan administrators then want a certified copy after the judge approves the QDRO.
If you are going through a divorce where a 401(k) needs to be divided, Stange Law Firm, PC can help. You can contact us at 855-805-0595.