Avoiding Penalties With A QDRO
Divorcing spouses in Texas may be able to avoid some penalties if splitting a 401K account by using a qualified domestic relations order.
In the midst of a divorce, the last thing a Texas resident needs to worry about is paying out high penalties or fees that may otherwise be avoided. Divorce may often bring about some natural amount of financial losses for people as assets must be divided between spouses. In addition, the cost of living as a single person is generally higher than the cost of living as a married couple.
This is a big reason why a qualified domestic relations order should always be used when a person must split a 401(k) account with a spouse during a divorce.
What exactly is a QDRO?
As explained by the U.S. Department of Labor, a qualified domestic relations order is a legal order that establishes the right of a person’s spouse to receive money directly from a retirement account in their name.
This is important because retirement funds are set up in one person’s name only. That person is generally the only one allowed to receive money from the account. When distributions by an account owner are taken for reasons other than those that meet retirement qualifications, penalties and fees may be assessed on the amount received. This in essence eats away at a person’s savings.
By using a QDRO, the nonaccount owning spouse becomes a named alternate payee on an account and may receive money directly as determined in a divorce settlement. The spouse that owns the account therefore avoids the early withdrawal penalties.
How are taxes handled?
According to the Internal Revenue Service, money received by either the account owner or the alternate payee may be subject to taxation. Again, the use of the QDRO avoids the tax liability for the account owner as that person would not actually receive any money.
The spouse who is the alternate payee may be able to avoid paying taxes when money is received by ensuring it is put into another retirement fund.
Is a QDRO only for one-time payments?
A qualified domestic relations order may be set up to facilitate one-time payments to an alternate payee or multiple payments to that person. The QDRO must be drafted with all such details carefully outlined, including the payment dates and payment amounts.
How do I get a QDRO?
There are many steps involved in ensuring a QDRO is properly created, including ensuring that the plan administrator approves the QDRO before any agreement is finalized. For this reason, Texas spouses should always work with an attorney who is knowledgeable about QDROs to make sure it is handled properly.