When Maryland couples get divorced, many will have to contend with dividing their retirement plans. The division of retirement accounts must be completed correctly. If an account is not divided correctly, both spouses might face tax consequences. Retirement plans are divided by either using qualified domestic relations orders (QDROs) or transfers incident to a divorce.
Division using QDROs
Qualified plans, which are plans that are governed by the Employee Retirement Income Security Act, must be divided using QDROs. These are specialized orders that tell the plan administrators how the assets in the account must be divided with the recipient spouses. A QDRO must be specific and clearly define the assets that will be transferred to the receiving spouse as funds transferred under a QDRO in a divorce. If the assets are not clearly defined, the plan administrator might not accept the order. The IRS might also assess an early withdrawal penalty and income taxes against the spouse who owns the account.
Division as transfers incident to a divorce
Non-qualified plans might not accept QDROs. These are plans that are not governed by ERISA. For these plans, the divorce orders must clearly define that the assets within the plan are to be divided as a transfer incident to the divorce. If the assets are not clearly identified as transfers incident to the divorce, both spouses might face tax penalties.
Transfers incident to divorce and QDROs are tax-free transfers when they are completed correctly. However, mistakes can expose either or both spouses to tax consequences. People will want to determine whether their plans are qualified or non-qualified and use the appropriate process to divide their assets. An account owner should not simply withdraw money and give it to the other spouse. Doing so will expose both the account’s owner and the recipient to tax consequences.