Why do I need a QDRO?

A qualified domestic relations order may help divorcing couples prevent unnecessary tax complications when splitting 401K accounts.

Among the many things that divorcing spouses in Maryland need to pay attention to are the potential tax consequences of their property division settlements. Forbes explains that when it comes to dividing retirement accounts, there can be right ways and wrong ways of doing this. The wrong way may well lead people to incurring taxes they do not otherwise need to incur.

When a 401K or other qualified plan is to be divided between spouses , the use of a qualified domestic relations order is needed.

Life without a QDRO

Every retirement account is setup in one person's name only. A couple's divorce settlement may outline provisions by which the non-account owner is to receive a portion of the account owner's 401K assets.

Without a QDRO, a distribution can only be made to the account owner who then must pay the other spouse. For any such distribution that is not clearly for retirement purposes, an account owner may be charged an early withdrawal fee. They may also have to pay income tax on the distribution.

The benefits of a QDRO

As explained by the United States Department of Labor, a qualified domestic relations order establishes the non-account owner as a payee on the account. This allows the plan administrator to make payments directly to that spouse instead of to the account owner.

The early withdrawal fees are avoided and taxes become the responsibility of the recipient spouse. If that person chooses to reinvest the money into another retirement account, the taxes may also be avoided at the time of receipt.

A qualified domestic relations order may also be used to allow a plan owner to tap into their 401K funds to satisfy a child support or a spousal support award. For spousal support, taxation responsibility rests with the recipient but for child support the plan owner retains tax liability.

Specific procedures must be followed

The Internal Revenue Service notes that the 401K plan administrator must review and approve a QDRO. It is important for any QDRO to be prepared early enough in the property division settlement process to allow time for this approval so that the approval is received before the divorce decree is finalized by the court.

Failure to complete any portion of the qualified domestic relations order process properly may result in complications later on. For this reason, it is advised that Maryland spouses in need of a QDRO work with an attorney who is experienced in drafting these documents.