401 (K) divorce distribution: what you should know
No one likes the thought of a marriage ending and when it comes time to divide and distribute possessions, it can get pretty uncomfortable. Statistically, 1 in 4 people who get divorced are age 50 or older- making it increasingly relevant to understand the legalities surrounding the division of retirement fund assets. Regardless of whether or not your divorce is amicable, your spouse- as well as any dependents- are entitled to a portion of your assets. Particularly with 401K distribution, understanding how the process works and what to expect can make a difficult and uncomfortable situation easier and less stressful.
In all cases, the court handles 401K divorce distribution by issuing a Qualified Domestic Relations Order (QDRO) to outline the specifics of dividing the retirement plan account. The QDRO essentially establishes a former spouse’s right to a portion of an ex’s retirement benefits and is used frequently to determine alimony, child support and property rights payments. A qualified attorney can help protect the funds in a 401K by ensuring the QDRO is accurate, valid and acceptable under the law. While the spouse distributing money from a 401K will not be subject to early withdrawal penalties, the receiving spouse will owe taxes unless the funds are rolled over into a qualified investment plan. Drafting the QDRO can be time consuming and difficult, which is why it is essential to thoroughly understand the plan administrator’s guidelines and use a skilled professional to get the job done quickly and efficiently.
What Determines How The Funds Are Divided From a 401K Divorce Settlement
Typically, the individual states determine how the funds in a 401K are divided. In most cases, divorce settlements follow equitable distribution, meaning that 401K assets accumulated during the marriage are divided in half. But it’s generally not that simple- there are other important variables to consider including the length of time and to what extent both you and your spouse contributed to the marriage. Currently, there are nine states (Texas, Arizona, California, Utah, Nevada, Idaho, Louisiana, Washington and Wisconsin) that consider accrued or invested retirement benefits community property. In these states, a 401K is typically divided 50-50 regardless of any additional marital assets. There are basically two different methods for dividing the funds from a 401K. You can conduct a “present day valuation buy out” or divide the funds into two separate accounts. Splitting the funds into two separate accounts simplifies the division process, and in most cases, allows you to continue to manage and contribute to the account as before. Understanding divorce settlement and how a 401K is divided can be confusing. It’s important to know that a former spouse and any dependents are entitled to a portion of the assets. Consider using the skills and expertise of a professional to help ensure assets are divided properly, reasonably and in a timely manner.