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401(k) Divorce Distribution: What You Should Know

Let’s face it, experiencing a Divorce Life transition can be challenging enough when it comes to dividing up possessions and agreeing on custody of children, let alone splitting retirement assets.

Who’s entitled to 401(k) divorce distributions?

Regardless of whether or not your divorce is amicable, your spouse – as well as any dependents- are entitled to a portion of your assets. Understanding how the process works and what to expect can make an uncomfortable situation easier and less stressful.

How the 401(k) divorce distribution process works

In all cases, the court handles 401K divorce distribution by issuing what is known as a Qualified Domestic Relations Order (QDRO). This document outlines 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.

Who can draft and review the QDRO?

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 complicated, 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 Funds Are Divided From a 401(k) Divorce Settlement?

Typically, the individual state laws determine how the funds in a 401(k) are divided. In most cases, divorce settlements follow an equitable distribution, meaning that 401(k) assets accumulated during the marriage are divided in half. But it’s generally not that simple- there are other essential variables to consider, including the length of time and to what extent both you and your spouse contributed to the marriage.

What are community property states?

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.

Present Day Valuation  Buy-Out options for 401(k) divorce distributions

There are two different methods for dividing the funds from a 401(k) divorce distribution. 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.

Receiving 401(k) distributions due after the divorce – what are your options?

Understanding the options available to receive 401(k) divorce distribution monies owed to you after a divorce is essential. Factors such as your age, post-divorce tax brackets (that can sometimes drop considerably), lifestyle income needs and more will help you know which way to move forward. If the process of distribution of any 401(k) monies is not handled properly, there can be a steep price to pay in penalties and taxes.

Avoid taxes and penalties – receiving 401(k) divorce distributions through direct transfers

If you are financially secure following your divorce, then rolling assets over into your own qualified retirement plan through a direct transfer may be best. This approach avoids you having to pay a penalty on the 401(k) distribution money received.

Age matters – the benefit of deferring your 401(k) divorce distributions until later

Holding off on taking a distribution until the account owner retires is another option. After he/she retires, you could either elect to take regular payments or receive a lump sum. On a side note, it is important to realize that if you do decide to leave the money in the plan, you’ll have to begin taking required minimum distributions starting at age 70 1/2 to avoid a penalty.

Lifestyle income needs – cashing out your portion of the 401(k) balance comes with penalties

Perhaps you could use some extra income to offset any financial strains of your divorce? Cashing out gives you the quickest and easiest access to the money. Beware, though, as this approach can be costly. If you haven’t reached age 59 1/2 at the time of the distribution payout, you might have to pay income taxes on it along with a 10% early withdrawal penalty.

Moving forward financially following your divorce

While a divorce transition is no matter to be taken lightly, there is some light at the end of the tunnel for spouses depending on income from 401(k) retirement assets. To gain a clear understanding of all your options, we recommend consulting with a CDFA (Certified Divorce Financial Analyst) Advisor.

CDFA Advisors learn and understand how to help their clients manage any retirement assets and pensions, among many other issues they face.

Because divorce can happen at any stage of life, the CDFA Advisors here at Second Opinion Partners are skilled and educated on how to help you to start fresh by helping you put your financial picture back together. We are here to help you get through it all, to include developing a plan to help you get back on track to meeting new goals moving forward.

Need Specific Help With Your 401k?

Interested in engaging a Second Opinion Partner CDFA Advisor to help you through your divorce transition? Schedule a complimentary consultation today to meet with us and learn more about our complete holistic planning services.

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