How the funds in 401(k) accounts are divided during a divorce

How the funds in 401(k) accounts are divided during a divorce

On Behalf of | May 15, 2024 | Divorce

Withdrawing funds from a retirement account early usually results in a hefty tax bill, but divorcing couples in Michigan and around the country may be able to avoid paying a tax penalty when they divide the funds in their 401(k) accounts. This is done by drafting a document called a qualified domestic relations order. QDROs should be drafted carefully to make sure that they satisfy the Internal Revenue Service’s requirements.

QDROs

A estranged couple will have to discuss the terms of a QDRO during property division negotiations. Michigan’s equitable distribution divorce laws require marital assets like the funds in retirement accounts to be divided fairly, but not necessarily equally. Once the terms of a QDRO are agreed upon, the document is signed by both spouses and submitted to the court for approval. Once a judge has reviewed and approved the QDRO, the document is sent to the plan administrator. The QDRO must name the spouse who will be receiving retirement funds as an alternate payee, and it must state the amount or percentage of the funds that will be transferred.

Avoiding tax penalties

Divorcing spouses who withdraw retirement funds transferred by a QDRO must pay income tax on the money, but they do not have to pay the 10% penalty that is usually assessed for an early withdrawal. In addition, they do not have to pay income tax on transferred retirement funds if the money is “rolled over” into an IRA.

Property division negotiations

Discussing how retirement funds will be treated in a divorce is an important part of property division negotiations. Drafting a QDRO allows divorcing spouses to divide these funds without incurring the usual 10% penalty for early withdrawals. If spouses place transferred retirement funds into an IRA account, they will not have to pay income tax on the money.

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