QDRO’s Provide for Ex-Spouses and Children

Incorrect Filings Lead to Large Tax Penalties

Divorce produces some of the most stress filled and anguished times of any person’s life, even in the “easiest” of divorces. When a couple has saved significant wealth over the years in retirement accounts, it might be necessary to divide them between the divorcing parties. If this is done improperly, then very large tax penalties, as much as 45% of the total of your retirement savings, may result.

Money saved in company 401(k) plans or IRA’s is sheltered from taxation during your working years. Any withdrawals before age 59 ½ trigger taxes on the withdrawals plus a 10% penalty. Imagine that a man and woman divorce and that the man has $100,000 in his company 401(k). In the interests of equality, they decide that the woman should receive $50,000 for her retirement.

Without proper planning, the man might be tempted to simply write her a check for $50,000 from the account, thinking that she can put the money in an annuity in order to preserve the tax deferred status of the growth in the account. What a surprise he’ll get next April 15th, when he realizes that he is liable for the income taxes on that money plus a $5,000 penalty.

A Qualified Domestic Relations Order (QDRO) Prevents Penalties and Premature Taxation

The QDRO is a judgment, decree or order (this includes property settlements) that relates to the provision of alimony, spousal or child support or property settlement. In order to satisfy the IRS and avoid tax penalties, a judge must issue the order. The mere fact that both parties agree to it is not sufficient to allow the parties to divide the funds without tax consequences.

Only Former Spouses and Dependents May be Beneficiaries

Originally, a qualified plan like a 401(k) allowed wealth to grow without taxation for the benefit of the employee who made the contributions. A QDRO allows this process to continue in the names of more than one person. The original owner might retain 50% of the balance of the account, while a former spouse or even a dependent child might get the remainder. The only alternate payees for a QDRO are spouses, ex-spouses and dependent children. As the name implies, people outside of the family cannot be granted a share in someone’s retirement accounts.

In the event that one of these parties is a minor or legally incompetent, then the order may require payment to someone with legal (fiduciary) responsibility for that party.

For more information, see the US Department of Labor’s Website, under Qualitifed Domestic Relations Orders.