Divorce will introduce you to a whole new set of legal and financial terminology, as well as acronyms. Understanding the processes, steps, and orders are essential to having a successful financial future. When you work with a financial expert, especially one who has experience supporting the divorce process, you’ll have peace of mind knowing you have the right orders in place to secure your portion of the retirement funds which in some cases requires Qualified Domestic Relations Orders (QDROs). In this post, we outline what you need to know about QDROs.
QDROs Defined
A Qualified Domestic Relations Order is a type of domestic relations court order, judgement, or decree that could pertain to property rights, spousal support, or child support. It assigns one party the right to receive some or all of the benefits of a retirement plan. More specifically, a QDRO requires that a portion of a private sector employer retirement plan be assigned or paid to a spouse in the case of a divorce.
QDROs are used for employer plans that are subject to ERISA laws, which include 401Ks, profit sharing plans, and pension plans. Accounts that do not require a QDRO include IRAs, Roth IRAs, Simple IRAs, and SEP-IRAs (which require applicable custodian transfer forms that are unique to each institution). Most public employer plans such as PERA (in Colorado), Thrift Savings Plans, Federal Employee Retirement System, and Civil Service Retirement System have their own unique process and forms.
You may wonder why you need this special documentation when most of your assets can be divided and agreed upon in your divorce decree. Retirement accounts are a little different. A retirement plan administrator can not legally split the participant’s funds to pay the former spouse following a divorce without a QDRO.
In your divorce, you must hire a qualified expert to draft a QDRO that outlines the terms of your agreement as they relate to the employer retirement plan. A retirement plan administrator must approve and accept these terms before it is submitted to the court for final signature and subsequent processing.
Take steps to get your QDRO started early as the total process of getting a QDRO drafted, approved, and processed usually takes a minimum of three months if your situation is not complex and documentation is in good order. The sooner a QDRO is processed post-divorce, the less likely you are to experience complications and potential conflicts that can arise concerning the division. Challenges that can surface include changes in account values, unanticipated death of the account owner, beneficiary issues, and estate problems. Acting early can help minimize post-divorce court proceedings, resolve issues proactively, allow both parties manage their finances appropriately, and help everyone move forward.
Tax Implications
When outlining a QDRO, there are no tax consequences for transferring funds for either party, as long as the beneficiary spouse deposits those funds into a retirement account like an IRA rollover or other qualified employer account. However, if the receiving spouse would like to withdraw from their portion of funds awarded through the QDRO, that can be written into the order. In this case, the beneficiary spouse can do so and avoid the 10% early withdrawal penalty (if they are not 59 ½ years old). However, those funds will still be subject to regular income taxes and mandatory tax withholdings (if applicable).
Once the QDRO is complete and the assets are divided, this QDRO exception to the 10% early withdrawal penalty does not apply. This exception is also only available to the receiving spouse and not the employee spouse who owns the account who must continue to follow allowable withdrawal instructions available to the plan.
Issues to Consider
In our experience, some common issues arise that require extra consideration in this process. Some of those top issues to talk with an expert about include:
- Date of Division: This will need to be agreed upon in the QDRO. It is typically the final decree date but there could be reasons to choose another date.
- Type of Division: You can divide the retirement accounts in different ways, such as a percentage or dollar split. This decision can be affected by the value of the account in a fluctuating market and/or future value expectations. The values you see during the QDRO process could change (even significantly) by the time you actually split up the accounts due to market volatility and the types of investments you have in the portfolio. If the receiving spouse is worried that the account may lose value in the future before the QDRO is complete, they can request that the employer spouse provide their portion in cash so that it is not subject to possible market losses before the transfer is complete. It is wise to speak with a CDFA to understand whether this is appropriate for your situation.
- Beneficiary changes: Outlining when beneficiary changes can be made, which is usually after the QDRO is complete.
- Comprehensive evaluation: If the employee spouse is the business owner of the plan, take extra precautions to ensure that not only the employer portion is being accounted for in the QDRO. Owner amounts could also be considered marital property and therefore possibly subject to division, in addition to the employee portion.
- Pension Plan Payouts: Each plan is set up differently regarding when a previous spouse (also referred to as ‘alternate payee’) can begin taking benefits. For example, some plans may only allow for an alternate payee to begin receiving payments after their ex-spouse ‘retires’ or begins taking benefits themselves. Other plans may allow the alternate spouse to begin payments any time after a specific age, regardless of whether the ex-spouse is ‘retired’ or has started receiving benefits themselves.
- Pension Plan Survivorship issues: It is important to review and understand how the retirement plan will operate in the event of the participant’s death and how it could affect the survivors benefit after a QDRO is completed. Plans vary significantly, which could affect the overall property division suitability.
Getting the right support early in your divorce is critical to successfully addressing the complexity of a QDRO. The team at A.M. Financial can help. A CFDA is your ally in this process and can help protect your financial future and retirement savings. As part of a holistic financial plan, based on your goals and vision, we can help you understand not only how a QDRO works, but also how to prevent an unexpected tax bill when you divide retirement assets. If you would like to learn more about our services, contact us for a complimentary consultation.