When a professional with a well-funded 401(k) faces divorce, their first priority might be the preservation of that account. In some cases, directly dividing the 401(k) is necessary due to a court order or to an agreement between the account holder and their spouse.
When that happens, the spouses may worry about tax implications and penalties. How can people divide a tax-deferred retirement savings account without incurring major losses?
There is a special document that helps
The final property division order does not automatically split the marital estate. The spouses have to execute deeds, withdraw funds from financial accounts and take other steps to fulfill the terms of the order.
In many cases, drafting a qualified domestic relations order (QDRO) may be part of that process. A QDRO is a document drafted by an attorney after the courts approve the final property division order. It should include the exact account division terms integrated into the court order.
Both spouses must sign the QDRO, and the courts must approve it. The final step is a submission to the financial professional or business managing the 401(k). The QDRO allows that professional to split the account by moving a specific percentage of its balance into a new account in the name of the other spouse. So long as neither spouse withdraws the funds after that split, they can avoid income tax consequences and the financial penalties associated with early withdrawals.
There are solutions for a variety of complex property division issues that can help people preserve their resources. Drafting a QDRO can be an important step to take if the division of a retirement account or pension is necessary during divorce.