Splitting Retirement Accounts During a Divorce

Divorce isn’t a happy topic, but it’s important for many reasons, including your retirement plan.

New Jersey is an equitable distribution state, which means assets and debts are split based on what the judge deems to be “fair and equitable.” This does NOT mean assets are split 50-50 down the middle. Instead, the court determines what split would meet the best interest of the family (especially the children).

Marital assets can include all items obtained–and wealth accrued–during the marriage. This includes retirement accounts, such as an IRA, 401(k), or qualified plan. Each type of retirement plan has a different set of rules. If you break them, there could be major headaches coming your way in the form of taxes and penalties.

What is a QDRO?

A qualified domestic relations order (QDRO) is a court order that awards a former spouse a cut of the other spouse’s retirement plan. They are required for private pensions and benefits plans such as a 401(k) or 403(b). They are not required for IRA accounts (more on that below).

The process of drafting and submitting a QDRO to the plan takes time and can be stressful for both parties. A divorce attorney can help you collect the information necessary to draft the QDRO and obtain spousal approval. As long as the contents of the QDRO are consistent with the terms of the divorce settlement, this shouldn’t be a problem.

Next, you must obtain the approval of the plan administrator. There are thousands of different plans, and each one has its own set of policies and rules. Don’t be surprised of the plan does not accept the QDRO right away–they may request some changes and ask you to resubmit.

With the approval of both former spouses and the plan administrator, the QDRO will be sent to a family court judge in the jurisdiction of the divorce. Hopefully that judge will approve and sign the QDRO, making it a legally binding order.

Splitting the Money

That is how the QDRO becomes a legal court order. Now you have to actually split the money! To transfer the funds, the plan administrator should create a new account for the ex-spouse who is receiving a portion of the money, and simply transfer the funds tax-free.

If you decide to withdraw the money–rather than transferring it directly into a retirement account in your name–you are going to get taxed. A portion of the money will be withheld by the plan for federal income tax purposes and the rest will be taxed like income. You may also face early distribution penalties of you are below retirement age.

If you don’t absolutely need the money right now, you should really keep it in the plan and let compound interest work its magic.

Divorced Couples Do Not Need a QDRO to Split an IRA

Rejoice! If you are trying to split assets within any type of IRA–including Roths, SEPs, and SIMPLEs–you do not need to endure the lengthy QDRO process. All you have to do is split the funds according to the terms of the divorce settlement.

If you are the spouse receiving the retirement funds, you should open a separate IRA account and have the funds directly transferred to that account tax-free.

Remember: If you decide to withdraw the money–rather than doing a transfer–you are going to get taxed. A portion of the money will be withheld by the plan for federal income tax purposes, and the rest will be taxed like income. You will also be subject to a 10 percent early distribution penalty if you are below age 59 ½.

Unless it is an emergency, the best course of action is to transfer the funds directly into a separate IRA account in your name and leave the funds alone. Let compound interest work its magic until it’s time for you to start collecting your required minimum distributions (RMDs).

Hire a New Jersey Financial Planner 

There’s no getting around it. Splitting retirement funds after a divorce is a pain. But it’s worth it. Retirement accounts are often the largest assets in a divorce. The small headache you feel today will be worth the security of knowing you have enough money to retire comfortably in the future.

For decades, Bodnar Financial has worked alongside divorce attorneys to navigate the QDRO process and help individuals execute 401(k) and IRA transfers responsibly. Contact us for a free consultation.