Deciding how to divide the retirement accounts, such as IRAs, 401(k)s and pensions is an important part of the divorce process.
Unlike closing a joint bank account and opening a new one in your own name, for example, dividing retirement assets can be a bit complicated.
We all know that taking a distribution from a retirement account will likely result in income taxes and possibly a 10% penalty. Fortunately, there is an exception to this rule when retirement assets are distributed due to a divorce.
A qualified retirement plan, meaning a 401(k) or pension, can be divided if a Qualified Domestic Relations Order (QDRO) is prepared, spelling out how much is to be distributed and to whom. This allows the retirement account to be divided without taxes and penalties.
The spouse receiving the assets can roll them into an IRA rollover account at the financial institution of their choice. The QDRO allows the funds to be distributed out of the original 401(k) but they must be rolled into an IRA to avoid tax. Once the assets are in the IRA rollover, they are treated just as any other IRA.
There is a one-time opportunity to take some of those funds in cash without penalty before the funds are rolled over. The decision to take out this cash must be made carefully. Although you may avoid a 10% penalty, the cash you take without rolling it over will likely be subject to income taxes. And it will reduce your overall retirement assets which may be needed later.
When it comes to dividing a pension plan, some allow distribution of a portion of the current cash balance which may be rolled into an IRA. Some require distribution of a portion of the monthly payments upon retirement. The difference between these two options is controlled by the pension plan document, and the plan administrator will explain the options of your particular plan. A QDRO will be required for this to be properly documented either way.
There is no plan administrator for an IRA and they don’t need a QDRO; but many financial institutions require a copy of the final Divorce Decree. Your attorney might be able to facilitate this sooner by preparing another type of less complicated order to satisfy the requirements.
The decision of how to divide your assets and the consequences of each, whether real estate, retirement or other investments is one of the most important decisions you will make during this process. Your collaborative divorce team is well aware of this and they will work closely with you to help you through the process.
By Diane Willis