Post Divorce Division of Retirement

Dividing retirement accounts post-divorce requires follow-up work and careful implementation to ensure the divisions in the decree are completed accurately and completely without delay.  The division of retirement is often the most challenging of post-decree divisions and can be done incorrectly or occasionally neglected altogether. This process can involve both non-qualified plans, like IRAs, and qualified plans, such as 401(k)s or pensions, which often require a Qualified Domestic Relations Order (QDRO).

Non-Qualified Plans

Non-qualified plans, such as Individual Retirement Accounts (IRAs), are typically easier to divide than qualified plans because they do not require a separate court order. Instead, the division is carried out using a certified copy of the divorce decree and the completion of any specific paperwork required by the financial institution.  You should contact the plan administrator of your particular account (such as Fidelity, Charles Schwab, or Ameritrade) to confirm the specific procedures. Here are the typical steps for dividing non-qualified retirement plans:

1. Obtain a Certified Copy of the Divorce Decree: Ensure you have a certified copy of the decree, which will usually be necessary for the division process.
2. Contact the Plan Administrator: Learn the specific procedures for implementing the division of retirement funds in line with the decree.
3. Complete Necessary Paperwork: Fill out any required forms from the administrator to facilitate the transfer. This may include forms specific to the institution and those required by regulatory bodies.
4. Transfer Funds: The institution will transfer the agreed-upon portion of the IRA to the other party’s account, ensuring the division complies with the terms of the divorce decree.

The funds are typically transferred directly from the original IRA to a new or existing IRA in the receiving spouse’s name, ensuring that the transfer maintains its tax-deferred status. This direct transfer, often referred to as a “trustee-to-trustee transfer,” avoids any immediate tax implications or penalties for the receiving spouse. The result is that each spouse ends up with their designated share of the IRA, held in separate individual retirement accounts, allowing them to manage their respective retirement savings independently and in alignment with their financial goals post-divorce. This process not only preserves the tax advantages of the retirement savings but also ensures a clear and equitable division as mandated by the divorce decree. For example, if the divorce decree specifies that the IRA is to be split 50/50, the financial institution will move half of the funds into a new or existing IRA account in the receiving spouse’s name.

Qualified Plans and QDROs

Dividing qualified retirement accounts such as 401(k)s, pensions, and other employer-sponsored plans during a divorce requires a Qualified Domestic Relations Order (QDRO, pronounced “quadro”). This legal document ensures that the division of these assets complies with both the divorce decree and the specific requirements of the retirement plan. Here are the steps involved in dividing qualified retirement accounts with a QDRO, along with practical tips for implementation.

1. Consultation and Drafting: Consult with an attorney or a QDRO specialist experienced in drafting these complex documents. This ensures that the QDRO is correctly tailored to the specific retirement plan and complies with legal standards. You should collect detailed information about the retirement plan, including the plan summary, participant statements, and any specific requirements outlined by the plan administrator. This information is essential for accurately drafting the QDRO.
2. Drafting the QDRO: Draft the QDRO according to the specific rules and guidelines of the retirement plan. The plan administrator may provide a model QDRO or specific language to use. Ensure the QDRO includes all necessary details, such as the names of the parties, the percentage or dollar amount of the account to be divided, the method of division, and any conditions for payment. Note that the spouse who is in the plan is called the “Participant” and the spouse to receive some of the retirement is the “Alternate Payee.”
3. Approval: Once the QDRO is drafted, it now needs to be reviewed and approved.  Some plans allow for a “pre-approval” process where the draft is sent to the plan and reviewed to confirm it will be approved as drafted once signed by the Court. The pre-approval process helps ensure the process will be efficient and smooth without added delay. Once pre-approved (or upon drafting if no pre-approval is allowed), then submit the QDRO to the court for review. This step ensures that the QDRO aligns with the divorce decree and is legally sound. The court will review and, if everything is in order, sign the QDRO, making it an official court order. This approved document is necessary for the plan administrator to act on the division.
4. Plan Administrator Review: After court approval, submit the signed QDRO to the retirement plan administrator. Include any required forms or additional documentation specified by the plan. The plan administrator will review the QDRO to ensure it meets the plan’s requirements and complies with ERISA (Employee Retirement Income Security Act) guidelines.
5. Implementation of the QDRO: Upon review, if the plan administrator requires any corrections or modifications, address these promptly to avoid delays.  The pre-approval may prevent these mistakes. Once the final entered QDRO is accepted, the plan administrator will implement the division as specified. This typically involves segregating the designated portion of the retirement account into a separate account for the receiving spouse.

Key Considerations

There are a number of particular considerations in division of qualified retirement accounts. First, while in a 401k, the QDRO typically identifies an amount or percentage of the balance for division, pension benefits legally recognize the right of an alternate payee to receive a portion of the pension benefits. The QDRO specifies the exact share or percentage of the pension that the alternate payee is entitled to, and the pension plan administrator is then responsible for implementing this division. Unlike the division of other retirement accounts, such as a 401(k) where the balance can be immediately segregated, dividing a pension plan involves designating a portion of the future pension payments to be paid directly to the alternate payee when the participant begins receiving their benefits. This method ensures that the alternate payee receives their share of the pension benefits over time, aligning with the original terms of the pension plan. The resulting division means that the alternate payee will receive periodic payments, often upon the retirement of the plan participant, rather than a lump sum distribution, reflecting the ongoing nature of pension benefits.

Second, you should understand and consider the fees associated with the implementation of a QDRO. The fees are typically addressed either by mutual agreement between the parties or by a specific directive in the divorce decree. The fees associated with drafting, submitting, and processing a QDRO can include attorney fees, court filing fees, and administrative fees charged by the plan administrator. Often, these costs are shared equally between both spouses, but in some cases, one party may agree to or be ordered to bear the full cost. It is important for the divorce agreement to clearly outline the responsibility for these fees to prevent future disputes and ensure a smooth division of retirement assets.

Finally, qualified retirement funds transferred to an alternate payee can be cashed out pursuant to divorce without penalty.  This option can offer immediate financial liquidity, which may be particularly beneficial for addressing post-divorce financial needs or investment opportunities. Lump sum distributions can have income tax implications, but you typically avoid early withdrawal penalties if the recipient is under the age of 59½. Cashing out retirement might alter the long-term financial benefits originally intended by the retirement plan. It may make sense for the alternate payee to consult with a financial advisor to understand the tax consequences and to consider the best use of the cash out option to align with their financial goals.

Implementing a QDRO requires careful attention to detail and proactive communication to ensure a smooth process. Start by maintaining clear and open communication with your attorney, QDRO specialist, and the plan administrator throughout the entire process to prevent misunderstandings and delays. Regularly follow up with the plan administrator to monitor the progress and address any required corrections or modifications promptly. The entire process, from drafting to final implementation, typically takes several months, with court approval and plan administrator review each adding several weeks to the timeline. Understanding the potential tax implications of the division is also crucial, so consult a tax professional to manage the newly received retirement assets effectively. Keeping organized records of all communications and submissions can help track the process and ensure compliance with all requirements. By staying engaged and informed, you can facilitate a timely and accurate division of the retirement assets.

Valuation Date

The valuation date in division of retirement is a critical element as it determines the exact point in time at which the retirement plan’s assets are valued for division between the parties. This date can significantly affect the amount each party receives, especially in accounts where the balance fluctuates due to market performance or contributions. The valuation date can be set as the date of separation, the date of filing for divorce, or any other specific date agreed upon by the parties or ordered by the court. Establishing a clear and agreed-upon valuation date ensures fairness and accuracy in the division of assets, preventing disputes over changes in account values that occur after the designated date. By clearly specifying the valuation date, the decree ensures that each party’s share is based on the account value at a precise, unambiguous point in time, reflecting the distribution intended by the divorce settlement. Whatever the agreed upon valuation date is, if it is included in the decree and then the documents implementing the retirement division, the funds transferred will be adjusted for gains and losses as if the division occurred on the valuation date.  

For example, if a decree indicated Wife was to receive $25,000 from a 401k as of 12/31/2023 (the valuation date), when the QDRO is finally implemented (let’s say 4/1/2024), the Plan will adjust the transfer to Wife to adjust for the market gains and losses as of 12/31/2023.  So if the market is up, Wife’s $25,000 will be adjusted upward and if the market has crashed, Wife would receive less.  The transfer to Wife should reflect what Wife’s $25,000 is worth on the date of transfer as if she had received it on the valuation date.