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The importance of a QDRO when dividing a 401K

On Behalf of | May 27, 2020 | Divorce

Tennessee residents who are getting divorced know they must split a variety of assets with their spouse as part of their marital split. This may include homes, vehicles, savings accounts and even retirement accounts. When it comes to employer-sponsored 401K plans, spouses should take care to ensure the sharing of any proceeds is properly documents so they avoid paying unnecessary fees or taxes. 

As explained by the U.S. Department of Labor, a retirement plan is setup with intention that money is not to be taken out of it until the plan holder reaches at least 59 years and six months old, the age that is considered legal retirement age. Any distribution prior to that point may result in the assessment of an early withdrawal penalty as well as income taxes. 

When a distribution is made to satisfy part of a property division award in a divorce, if the plan holder simply takes money out of the account and pays it to their former spouse, they may be hit with the penalty and taxes. If, however, a qualified domestic relations order is used, these may be avoided. 

According to the Internal Revenue Service, a QDRO legally names the other spouse as a payee on the 401K account, allowing money to be paid directly from the plan to that person and bypassing the account holder altogether. The QDRO also prevents any early withdrawal fees from being assessed. If the spouse puts the money into another qualifying retirement plan, they may also avoid paying income taxes at the time they receive the funds from their spouse’s plan.