Qualified Domestic Relations Orders (QDRO) are expensive; they are required in order to transfer pension assets in a divorce without incurring the 10% penalty for early withdrawal. But many financial institutions will transfer a 401(k) without a QDRO, and just have you sign a simple form instead. Seems like a good idea — look at all the money you save. Is there a catch?
Don’t Incur A Needless Tax Penalty in Divorce.
Unfortunately, there is. If the QDRO is not properly prepared and signed by a judge, you will be subject to the federal income tax 10% early withdrawal penalty. You could end up being subject to a tax on monies that you have already transferred to your spouse pursuant to the divorce settlement.
How to Avoid a Needless Tax Penalty in Divorce.
To be valid the QDRO must meet two criteria: it must be correctly created and it must be correctly verified.
To be correctly created it must have been signed by a Judge and it must contain the following information:
1. your name and most recent mailing address.
2. the name and address of your spouse (known as the alternate payee).
3. the amount or percentage of the account that is to be paid to your spouse.
4. how the amount or percentage that is to be paid to your spouse is to be determined or calculated.
5. the number of payments or the period of time to which the QDRO applies.
6. the name of the Plan to which the QDRO applies.
The second thing that must be done is the QDRO must be validated, that is, the Plan must determine that it is legally valid and what they must do about it. That is often done in a preapproval process, before the QDRO is submitted for signature to the Court. One way or another, however, the Plan must do the following:
1. notify you and the alternate payee that it has received the QDRO and explain to you how the Plan will determine its validity.
2. determine within a period of no more than 18 months whether the QDRO is valid or not; this is almost always done through a pre-approval process.
3. account for any payments to be made to the alternate payee during the evaluation period.
4. notify you and the alternate payee whether the QDRO is valid or not.
It can be an expensive process, particularly if your divorce involves a number of pension assets that must be transferred. Each QDRO can run about $1,000.
Don’t let convenience get the better of you. Do it right, or you pay a great deal in unnecessary taxes.
Now please return to the financial planning Divorce Mediation page.