Retirement accounts such as 401(k)s or IRAs are often considered marital property and therefore are subject to division in a divorce. Because these plans are tax deferred, there are rules in place to restrict early withdrawal. Figuring out the best way to divide retirement accounts during a divorce will depend on a number of factors, including the types of accounts, each party’s retirement savings goals and the former spouse’s immediate cash flow needs.
Whether your savings are in a 401(k) or an IRA, when immediate cash flow is not an issue, it is best to find a method of dividing the assets that will not incur a tax penalty for either party. The most commonly used option for transferring funds from a 401(k) account in cases of divorce is known as a “qualified domestic relation order” or QDRO. The QDRO is a court order permitting the transfer and distribution of account funds from the “participant” spouse to the “non-participant” spouse. If the parties utilize a QDRO to divide a retirement asset, the non-participant spouse can opt for one of several options depending on the rules of the plan and personal preference:
- Direct rollover of funds to the non-participant’s new or existing individual IRA; or
- Take a partial or full lump sum distribution prior to rollover, subject to regular income tax but without a 10% early withdrawal tax penalty.
If the savings are in an IRA account, the choices are either to change the name on the account (if all the funds are going to the former spouse).
In cases where a spouse has an immediate need to access the retirement savings and the parties do not use a QDRO, a partial or full lump-sum cash out may be required. In these cases, the funds will likely be subject to a withholding tax and income tax, and if the former spouse is under the age of 59 1/2, the distribution amount will also be subject to a tax penalty.
The division of marital property is one of the most challenging aspects of a divorce, and the division of retirement assets can seem overwhelmingly complex. It is important to consult your attorney, financial planner, or tax professional to determine the most advantageous solution to safeguard retirement savings for both parties. Choosing the wrong option could result in a party violating a temporary injunction and paying taxes or penalties that could have been avoided.
