Figuring out how to divide up shared assets when getting divorced may cause a lot of challenges for spouses as they work through the emotions associated with losing things that mean a lot to them whether financially or personally.
A retirement account often gets shared between divorcing spouses even though it is in only one spouse’s name. Details about how a 401K’s assets are to be split may be detailed in a couple’s divorce decree, but that may not be sufficient.
401K distributions, penalties and taxes
As explained by the United States Department of Labor, when the owner of a 401K takes a distribution from the account for purposes other than retirement, early withdrawal fees and taxes may be assessed. This ends up significantly reducing the amount of money received by the person. If an account owner withdraws money from their 401K to pay a former spouse per a divorce decree, they may end up in this situation.
The qualified domestic relations order
A qualified domestic relations order allows the spouse who does not own the 401K account to be named as a legal payee on the account. With the approved QDRO in place, the former spouse may receive distributions directly from the account per the terms of the divorce settlement. No early withdrawal fee assessment occurs on these distributions.
Tax liability for distributions made directly to a former spouse end up with the recipient versus the account owner. The Internal Revenue Service explains that the former spouse may avoid paying taxes on the 401K distribution at the time the money is received if they reinvest the money into another retirement account.