What are the benefits of a QDRO?
When splitting retirement accounts during a divorce, special care is needed to avoid high taxation and early withdrawal penalties.
When working through a property division settlement, divorcing couples in Brooklyn commonly know that retirement accounts may be split in the process. Depending upon the type of account involved, there can be some serious tax penalties, especially if the account is not properly managed in the process.
For company-sponsored funds, like 401(k) accounts, a divorce decree alone is only one piece of documentation needed. If this is the only thing relied upon, account holders can find themselves subject to steep tax and penalty bills.
How can this be?
These funds are set up to hold money until the qualifying account holder reaches retirement age. Money taken out prior to this can be subject to taxes and early withdrawal penalties. This is so even when a divorce court document stipulates that the account be split as part of the marital property division .
An example of this is given by Forbes. When a family court judge ordered a man to pay his former wife more than $50,000 for her portion of alimony, the man did so. Despite following the instruction of a judge, the man was presented with a tax bill for 10 percent of the value he paid to his former wife.
Can this be avoided?
The use of a Qualified Domestic Relations Order is the way to avoid these taxes. According to the U.S. Department of Labor, a QDRO sets up an additional payee in a retirement account. Using the example above, the former wife would have been added to the account as a payee and the former husband would therefore not have been taxed on the distribution.
The Internal Revenue Service also notes that a Qualified Domestic Relations Order can be used when retirement monies will pay alimony or child support or when an account is split as part of a property division agreement. If the distribution is to satisfy property division terms, the money will not be taxed at all so long as the receiving spouse reinvests it properly.
Caution is urged
A QDRO is a powerful document but must be created according to all guidelines in order to have any power. The specific amount or percent to be distributed must be clearly identified. So too should details about whether the distribution will be in a lump sum or in multiple payments over time.
Because of the details involved, New Yorkers are encouraged to talk to an attorney when they believe they may need to split their retirement accounts in a divorce.