For over two decades, I’ve been helping prepare Qualified Domestic Relations Orders for clients across the nation who are going through a divorce. During that time, one thing I can say for certain is that most people have no idea what a QDRO is – until they need one themselves.
If you find yourself in that position, here’s a quick summary of QDRO basics that you should know before you begin divorce negotiations.
What is a QDRO?
A Qualified Domestic Relations Order is a legal document, signed by the court, that orders a qualified retirement plan (401K, pension, etc.) to award a portion of a plan participant’s account to an alternate payee – typically the plan participant’s ex-spouse.
Why would you need one?
Usually, the need for a QDRO arises in the context of divorce. To ensure an equitable division of property, a portion of one spouse’s retirement account may need to be awarded to the other spouse. If the plan is covered by federal ERISA rules, then a QDRO is usually required. There are other circumstances when a QDRO may also be appropriate. For example, if a plan participant fails to meet their court-ordered child support obligations, then a QDRO may be used to collect past-due amounts.
When should you have the QDRO prepared?
Typically, the QDRO should be prepared toward the end of the divorce process, after negotiations are completed. However, not every divorcing couple takes care of getting the QDRO done right away. There are many reasons why – lack of funds, simple oversight, not understanding the importance of preparing the QDRO right away.
The general rule of thumb I tell my clients is to have the QDRO prepared as soon as you and your ex have agreed to the details of your split. Delaying (or failing to prepare the QDRO at all) can lead to very unintended and detrimental results for the alternate payee.
What are the risks of delaying the QDRO?
If there is a delay in obtaining the QDRO, the spouse entitled to receive benefits via QDRO may lose the rights to the retirement benefits awarded to them during the divorce. These rights can be lost if the alternate payee’s ex-spouse does any of the following before the plan administrator receives and accepts the QDRO:
Dies
Quits or gets fired
Retires
Remarries
Takes out a loan against the plan
Withdraws funds from the plan before retirement
It is very important to promptly get the QDRO ball rolling. Without it, the alternate payee may lose their share of valuable marital assets forever.
How can you cash out of a QDRO in California, before the age of 55, without incurring the 10% tax penalty?
Typically, the IRS imposes a strict 10% tax penalty if a plan participant, under the age of 59 ½, withdraws cash from a qualified retirement plan. However, the IRS makes an exception if it is the alternate payee who makes the withdrawal.
When an alternate payee wishes to take cash from their portion of a qualified retirement plan, they can avoid the mandatory 10% penalty if all the following conditions are met:
The retirement plan must be a qualified plan covered by ERISA (e.g. 401K and other similar defined contribution plans)
A QDRO must be used to divide the plan
The funds must be awarded to the alternate payee (NOT the account owner)
It is important to keep in mind that any cash received will still be treated as ordinary taxable income to the alternate payee, and that the plan will withhold 20% of the distribution to cover this liability. If you’re planning to take out cash from your QDRO award, please keep this in mind.
About the Author: Dr. Robert Hetsler, Jr. is an expert in the areas of Qualified Domestic Relations Orders, tax and forensic accounting. He is a Harvard-trained financial specialist and regularly advises clients and provides expert witness services regarding the division of retirement and pension accounts in divorce cases around the country. He is the author of seven books on various divorce topics, and is a trained family mediator. Learn more about Dr. Hetsler here.