Saving for retirement takes a lifetime of hard work and diligent saving. It can be difficult to watch your former spouse gain a portion in divorce. In some situations, however, the value of a 401(k) might be easier to let go than other marital assets. For other couples, dividing a 401(k) is somewhat unavoidable.
In comparison to other assets, splitting a 401(k) can be very complicated. Regardless of what caused you to think about how to divide retirement funds, you and your former partner should know that there’s a right way and a wrong way to go about the process.
Before drafting anything about retirement funds in your divorce agreement, make sure you have an experienced attorney at your side. People who are unfamiliar with this niche area of law could easily miss important facts. There are many special rules and details that govern 401(k) plans, so it’s best to work with someone who you trust to provide strong guidance.
Actually, specific information about splitting the 401(k) will not be located in your divorce agreement at all. Instead, you will need to create a different legal document: a qualified domestic relations order (QDRO). The QDRO’s basic function is to officially instruct your 401(k) plan administrator how to distribute the funds. This document outlines how much of the 401(k) the other person will receive after your divorce.
Within the QDRO, the spouse who receives the portion must specify whether they decide to place that value in their IRA or if they would like to cash out. If they do want to withdraw the value, this transaction will be taxable as income and there may also be a percentage-based penalty.
In general, splitting retirement accounts can create complex issues if you don’t approach the subject carefully. With good planning and guidance, however, you can avoid many legal, financial and tax-related pitfalls.