Guarding against 401K losses in a divorce

On Behalf of | Oct 13, 2020 | High Asset Divorce |

Divorce is commonly associated with so many losses in a person’s life, including financial losses. The need to divide a marital estate unfortunately makes this an inherent part of the process.

However, when it comes to splitting a 401K account with a spouse, a person may have the ability to prevent some losses based on how they manage this asset split.

Withdrawals from 401K accounts

Under normal circumstances, any withdrawal from a 401K or other retirement account sponsored by an employer and funded with pretax dollars may be subject to early withdrawal penalties if the person receiving the money is younger than 59 years and six months old. This may include withdrawals made by an account owner and then paid to a former spouse per the agreement outlined in the couple’s divorce decree.

The QDRO and the authorized payee

Divorcing spouse may avoid these early withdrawal penalties by implementing the qualified domestic relations order. The U.S. Department of Labor indicates that a QDRO allows the account owner’s spouse to be identified as an authorized payee on the account. Once the plan administrator approves the term of the QDRO, distributions may be made directly to the authorized payee with no assessment of early withdrawal penalties, saving a sizeable portion of the asset from unnecessary loss.

Taxes and the QDRO

Because a 401Ks is funded with pretax dollars, a recipient may owe taxes when making a withdrawal. The QDRO ensures the authorized payee, not the account owner, assumes responsibility for these income taxes. The Internal Revenue Service explains that taxes may be deferred if the authorized payee reinvests the money received into a new retirement plan.