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 being divided as part of the property division aspect of a divorce. 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, however, the 401(k) has to be divided because it is the only equitable way to achieve a just division of marital property and debt.
To divide a 401k, 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.
- Draw up a QDRO, which describes to the plan administrator how it should be 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 is known 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 when those payments are to be made is necessary.
To understand the divorce impactions of splitting a 401(k), it is important to know the options as a separated couple. Thus, 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. This is permissible as long as this is done via transfer. If the spouse decides to leave the funds in the account until they retire, they will also avoid paying taxes until that time.
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. If that person is the receiving spouse, this is a great way to take the benefits now as opposed to roll them over until later. There will be income tax consequences for doing this.
An important thing to consider is that if one is considering 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 that person decides later to cash it out. Even if there is a QDRO that has been issued, it is important to do things in an efficient manner.
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 in an efficient manner. The plan administrator should get back to the parties promptly. It is important to note that if a significant time passes, a follow-up is often important. If a QDRO is in place, it is a person’s right to contact the plan themselves as a prospective alternate payee and ask about their spouse’s benefits. There should be no push back because the laws under the Department of Labor give a person a right to said information.
In terms of practical drafting tips, getting QDROs pre-approved by the plan administrator before the parties signing can be vitally important and can ensure the plan administrator does not reject a QDRO after they have signed it. Further, the parties should also 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 agreeing to move their money without their written assent. 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.