A qualified domestic relations order may help divorcing Arizona spouses avoid taxes and penalties when splitting 401K accounts.
When getting divorced, Arizona residents often have to figure out what assets they need to split or simply give up to the other spouse, potentially in exchange for retaining other items. Either way, retirement accounts are commonly part of this overall equation. In addition to homes, these funds can be some of a couple’s most valuable assets.
If a property division settlement requires the spouse who owns a 401K to share some of the value of that account with the other person, how should that be done?
Retirement means retirement
Retirement accounts are set up to fund retirement as their names indicate. That means that withdrawals from these accounts for non-retirement purposes may be subject to fees or taxes that may not otherwise be assessed. If the person who owned an account simply took money out and paid it to a spouse per a divorce decree, this might happen.
According to the Internal Revenue Service, a qualified domestic relations order may help to avoid unnecessary taxes or early withdrawal fees in such a situation. The QDRO works by naming the non-account-owning spouse as a legally qualifying alternate payee so that money can be paid directly to them. The QDRO would outline the payment details which might include a one-time payment or a series of periodic payments.
Proper approvals are important
The United States Department of Labor explains that the details of any qualified domestic relations order must be approved by the fund administrator. When creating a QDRO, time should be allowed in order for this to happen so that a divorce decree is not approved first and then after the fact a QDRO is for some reason denied or changes to it are requested by the administrator.
The Balance adds that not all types of retirement accounts require the use of QDROs. Funds that fall under the governance of the Employee Retirement Income Security Act of 1974, like 401Ks, are those for which a QDRO is necessary.
How taxes are handled
For distributions made directly to a spouse or former spouse per the stipulations of a QDRO, that person is responsible for paying any income taxes on the money. If, however, they put that money into another 401K or other type of retirement fund, the taxes may be able to be avoided at the time of receipt.
Seeking the right guidance
Arizona spouses who may need to split retirement funds during their divorce should always work with an experienced family law attorney. There are many details that must be taken care of when preparing a QDRO in order to avoid any problems with the eventual distributions.