Divorce reduces a marriage to a business transaction, and dividing the financial world of two people who were working together to build assets can be a challenge. While the house was at one time the largest marital asset, the retirement plan has become a major part of many couple's portfolios. Complicating matters further is that most retirement plans are tax-advantaged accounts, and not following careful instructions when dividing these plans can mean you pay more in taxes and penalties than you have to.
The laws in most states call for an equitable division of marital assets. Still, the division of all assets is negotiated between the two people. One spouse may receive a larger portion of home equity, in exchange for the other spouse claiming a larger portion of the retirement assets. But often, the retirement accounts are split evenly between the two. If the couple cannot negotiate the division of the retirement accounts on their own, the court will have to issue a decision for them.
Qualified Domestic Relations Order
A qualified domestic relations order is specific language that is included in your divorce papers. The QDRO is used for employer-sponsored plans, and it gives the spouse who is not the participant in the plan the right to claim a certain dollar value or percentage of the retirement plan. The person receiving the funds can directly roll the money into her own IRA and be responsible for any applicable taxes and penalties when she withdraws funds from the account.
Defined Benefit Plans
Once the most common forms of pension plan, the defined benefit plan, where the pension fund pays out a certain monthly amount at retirement based on years of service or other criteria, is also subject to division in a divorce. The divorce settlement can include a portion of these benefits being paid to the other party at retirement. The QDRO is used to orchestrate this division, either by a percentage or fixed amount. For example, the QDRO can specify that the other party receives $500 per month, or 40 percent of the benefit.
Employer Plan Concerns
Most large companies are familiar with the QDRO paperwork and can handle the transfers correctly and without unnecessary tax implications to the employee. The QDRO paperwork in the divorce must state that the domestic order is being established under state domestic relationship laws and Section 414(p) of the Internal Revenue Code to avoid later consideration of the transfer as a taxable event.
Individual retirement accounts do not need a QDRO to be split. The divorce property settlement will dictate how the IRAs are to be split, and with that order you can roll the correct amount of money into an IRA set up for your spouse. The order must specify that the transfer of funds between the spouses is a tax-free transfer under 408(d)(6) of the Internal Revenue Code. Your spouse can then access the money and pay the taxes and penalties as appropriate.
Be careful that any transfer of retirement assets is done inside of the divorce orders, with the correct language. If you transfer retirement assets outside of a valid divorce order, you will be responsible for paying taxes at the normal income rate on the money transferred, as well as a 10 percent penalty if you are under age 59 1/2.
- mases peleandose 2 image by juanjo tugores from Fotolia.com