A common question regarding divorce is whether a future ex-spouse has a claim on their partner’s retirement account. The answer is “yes,” retirement accounts are often the largest marital asset needing division. A Qualified Domestic Relations Order can make division possible without excessive tax consequences.
The Internal Revenue Code permits certain distributions from a plan as part of divorce proceedings. If the court-issued Domestic Relations Order (DRO) is deemed a Qualified Domestic Relations Order (QDRO), parties may divide the retirement balance with the following effects:
No Income Tax
The participant does not pay income tax on the distribution. The ex-spouse (alternate payee) may roll over their share and not pay tax on the amount until withdrawn.
No Excise Tax
The alternate payee avoids the 10% excise tax on withdrawals prior to age 59½. This is only available at distribution from the original plan, not once the funds are rolled over.
Many participants misunderstand the procedure for obtaining a QDRO. The procedure is as follows:
Most divorces end with a stipulated settlement signed by the parties and filed with the court for approval. A settlement agreement is not a QDRO; it sets the stage for obtaining one.
Once the court approves the settlement, it issues a decree or judgment. The divorce decree mirrors the settlement terms and covers all aspects of the divorce. Although a divorce decree can be drafted as a QDRO, it normally does not meet the necessary criteria.
Domestic Relations Order
Like the settlement, the attorneys prepare the DRO and submit it to the court. The DRO addresses how and when the retirement account will be divided between the parties.
Plan Administrator Approval
A judge’s signature on a DRO does not make it “Qualified.” Divorce courts have jurisdiction over divorcing parties, but not the tax consequences of property division.
The order may even be captioned “qualified domestic relations order” but that does not make the order acceptable to the IRS. Only the Plan Administrator can determine that the DRO meets all IRS criteria and is, therefore, a “Qualified” Domestic Relations Order.
Parties can avoid costly delays in the approval process by following these tips:
Use a Template
Alerus provides attorneys with a QDRO template to save time and facilitate administrator review. Failure to use the template could result in additional fees and delays if the QDRO must be sent to an independent counsel for review.
Use a Checklist
A QDRO has many technicalities, and a checklist can help assure they are all met. Alerus can provide you or your attorney with a checklist to ensure compliance.
Obtain Prior Review
Attorneys should present a draft of the order to the plan sponsor before filing so needed changes can easily be made. This saves time and avoids unnecessary fees to the client.