For many couples, a family home and a 401K account represent the largest portion of their shared assets. Dividing these items during a divorce can therefore create great complications and concerns for both parties.
Spouses do need to protect their financial futures and the decisions they make during divorce negotiations play into this, including whether or not they split a 401K account and how they may do so.
Options for a 401K split
One spouse may agree to share part of his or her 401K account with the other spouse as part of their property division settlement. The account owner may assume he or she should take money out of the account and then give it to the spouse. However, the U.S. Department of Labor indicates the account owner should instead use a qualified domestic relations order so the spouse receives the money directly.
With a QDRO, the spouse becomes an authorized payee on the 401K account, eliminating the need for the account owner to take a distribution or otherwise be involved in the transfer of funds to the spouse. This prevents the assessment of early withdrawal fees on the spouse for any money taken out, saving a notable portion of the full retirement asset. The recipient also avoids paying any penalties.
Taxes and a QDRO
When taking money from a 401K, a person generally pays income tax on the funds received. The Internal Revenue Service indicates that an authorized payee may avoid income tax assessment at the time of receipt per a QDRO by reinvesting the money directly into another retirement fund.