Many companies offer 401(k) retirement plans to their employees. These plans allow an employee to invest a percentage of pre-tax earnings into a retirement account and sometimes get matching contributions from the employer. If the employee gets divorced, the ex-spouse may demand up to half of the retirement account, depending on whether all of the funds in the account were accumulated during the marriage. In a divorce, splitting the 401(k) may be the only way to reach a settlement on the separation of retirement savings.
Qualified Domestic Relations Order
If the couple decides to split the 401(k), they will need their attorneys to agree on the terms of a qualified domestic relations order, or QDRO. The QDRO is a court order that demands a portion of the account be turned over to an alternate payee. For the QDRO to be implemented, the order must comply with the guidelines of the retirement plan. Submission errors in the QDRO to the plan administrators can cause the order to be rejected, which can delay the split of the 401(k) for months or years and create more attorney fees for the splitting couple.
Withdrawing Part of the 401(k)
A faster and costlier method of splitting the 401(k) would be for the employee to withdraw the portion of the 401(k) that is due to the ex-spouse under the settlement agreement. This withdrawal would be subject to the 10 percent early withdrawal penalty if the account holder is younger than 59 1/2 years old, and the couple would need to determine who is responsible for paying the penalty. If the ex-spouse needs the money immediately to pay off other expenses, he might be willing to pay this price. The time required to make a withdrawal is determined by the plan administrator, but a withdrawal is certainly faster than drafting and executing a QDRO.
Rolling Over Into an IRA
If the employee has left the company or is older than 59 1/2, he could withdraw the ex-spouse's agreed-upon settlement portion of the retirement plan without being assessed a penalty as long as the money is rolled into the ex-spouse's 401(k) or an individual retirement account. This rollover needs to happen within 60 days to avoid the early withdrawal penalty of 10 percent of the withdrawn funds.
Paying a Lump Sum
Another option the couple might consider would be for the employee to pay her ex-spouse an amount of cash or other assets equal to the value he would receive from the split of the 401(k). In this manner, the ex-spouse receives the portion of the retirement account he is due, but the divorcing partners avoid the hassle and attorney fees of drafting and executing a QDRO.
Chris Baylor has been writing about various topics, focusing primarily on woodworking, since 2006. You can see his work in publications such as "Consumer's Digest," where he wrote the 2009 Best Buys for Power Tools and the 2013 Best Buys for Pressure Washers.