What Is a QDRO?
A qualified domestic relations order (QDRO) is a decree or court order that requires that a portion of a retirement plan be assigned or paid to another person, such as a spouse or dependant, in the case of a divorce. Typically, during a divorce, the couples’ assets are divided, but since that split doesn’t automatically extend to retirement plans, a QDRO is used.
A QDRO is helpful since the retirement plan administrator can not automatically split the participant’s funds to pay the former spouse following a divorce without the QDRO in place. However, different rules can apply for divvying up the assets, depending on the type of retirement plan. A process called “transfer incident to divorce” is used for individual retirement accounts (IRA), while QDROs are used for 403(b)s and qualified plans, such as 401(k)s.
In this article, we will explain how a QDRO works, who is responsible for completing the QDRO, the benefits and limitations of a QDRO during a divorce settlement.
- A qualified domestic relations order (QDRO) is a decree requiring a portion of a retirement plan to be assigned or paid to another person, such as a spouse following a divorce.
- A QDRO helps the division of assets to be done more efficiently as a result of a divorce.
- QDROs typically cover the distribution of retirement plans.
- The alternate payee gains part of the retirement benefits from the former spouse.
How a QDRO Works in a Divorce
A QDRO is a court order used to divide specific types of retirement plans, including qualified and 403(b) plans. According to the Internal Revenue Service (IRS), a QDRO is “a judgment, decree, or order for a retirement plan to pay child support, alimony, or marital property rights to a spouse, former spouse, child, or other dependents of a [retirement plan] participant.”
A QDRO must comply with the Employee Retirement Income Security Act (ERISA) and the domestic relations laws within the state that has jurisdiction. ERISA was established by the U.S. Congress to provide a regulatory framework for employer-sponsored retirement plans to provide protections for beneficiaries and participants.
A QDRO grants a person known as the “alternate payee” the right to a portion of the retirement benefits that the former spouse (the “participant”) earned through an employer-sponsored retirement plan. A QDRO allows a former spouse to receive a predefined amount of their spouse’s retirement plan assets.
For example, a QDRO might pay out 50% of the account’s value that has grown during the marriage. The funds, as a result of the QDRO, could then be transferred or rolled over into an IRA for the beneficiary spouse. While a QDRO provides benefits to an alternate payee when the participant is alive, it can also award survivor benefits if the participant dies.
Who Can Be an Alternate Payee?
A QDRO can be used to assign funds to a child, as in the case of child support payments. It’s typically used for assigning a portion of a person’s retirement money to a spouse or ex-spouse as part of the transfer of marital property rights in a divorce. A QDRO allows the creation of alternate payees from a retirement plan provided they’re a dependant, spouse, or ex-spouse of the plan participant. The beneficiary is granted the funds and can have the money transferred to an existing or new retirement account in their name.
Who Is Responsible for Completing the QDRO?
Typically, the beneficiary spouse will contact an attorney or lawyer to draft a QDRO document to transfer the funds. However, the retirement plan administrator may also have a standardized form for the QDRO.
The drafted QDRO is submitted to the retirement plan administrator, and once it’s accepted and approved by the administrator, it’s submitted to the court. Since divorces can be complex, particularly if a couple has many assets, a lawyer may be a good option to help ensure a smooth transfer of assets.
Benefits of a QDRO
A QDRO helps the transfer of assets in a divorce to be more efficient and seamless. Also, there’s no ambiguity surrounding the amount of the assets being transferred, which helps to reduce any potential issues between the divorced couple. By assigning the benefits, the QDRO helps ensure that the ex-spouse will have a retirement nest egg.
One benefit for the spouse making the payout is that there is no early withdrawal penalty by the IRS for transferring the funds to the ex-spouse. Typically, the IRS charges a 10% tax penalty on any funds withdrawn from an IRA if the person is under the age of 59½.
The beneficiary receiving the funds is not taxed either, as long as the funds are put into another retirement account. If the funds are distributed, income taxes will be levied, and if the person is under the age of 59½, there’ll be an additional 10% tax on the distribution amount. However, the individual paying out the funds does not pay any taxes on the distribution. Instead, the beneficiary spouse pays those taxes if they decide not to transfer the funds into a retirement account.
A QDRO should contain instructions in the event a loan has been taken out against the 401(k) by the participant. Otherwise, the beneficiary’s assigned amount could be reduced by the outstanding loan balance.
Limitations of a QDRO
Although there are benefits, there are also some limitations to a QDRO. Assets within a retirement plan will not be transferred under a QDRO if those funds are already promised to another alternate payee via another QDRO.
Also, only benefits that the retirement plan administrator offers can be included in the transfer of the assets. In other words, new benefits or choices can’t be added for the benefit of the ex-spouse if those benefits are not currently offered by the retirement plan.
It’s important to check the details within the pension or retirement plan. If contributions by the plan participant and the employer have been made for several years before the couple was married, those funds would not be included in the QDRO.
The amount of money paid out during the divorce settlement would be limited to the contributions during the marriage. If the participant wanted to protect their pension or retirement plan, they could offer the ex-spouse an alternative amount of assets such as the house or other savings.
What’s Included in a QDRO Form
Although there are many private retirement plans in the United States and states may have their own specific requirements, QDROs may include the following:
- Name and last known mailing address of the participant and alternate payee(s)
- Name of each retirement plan that the QDRO is designed to cover
- Dollar amount or percentage of the participant’s benefits to be paid to the alternate payee(s). The QDRO must state how the percentage or dollar amount was determined
- The time frame for which the QDRO applies, including commencement date and the number of payments
- What happens in the event of the death of the participant and alternate payee
- What happens if the retirement plan is terminated
Please note that a QDRO can’t award an amount or form of benefit that’s not available under the plan. Also, the court may include additional provisions, depending on its jurisdiction and state laws.
How Is a QDRO Paid Out?
Distributions from a QDRO can be done in a few different ways, and the QDRO would spell out how the money is to be allocated to the ex-spouse. In the case of retirement plans, the money may be divided up and a portion allocated to the ex-spouse—a process called the separate interest approach. This approach requires the QDRO to specify the percentage or dollar amount to be allocated to the ex-spouse.
Types of Payments
The ex-spouse could opt to receive a lump-sum payment for the percentage of assets in the plan. If the lump sum amount is transferred into a non-IRA account, the beneficiary would need to pay income taxes on that distribution. The funds could also be transferred into another retirement account on behalf of the beneficiary to avoid tax implications.
The beneficiary can also opt to receive the assets in installments, which can help spread out the income received over a period of time. Another option that might be available is to leave the money in the spouse’s plan but retain the ability to invest your portion as the alternate payee. You would have to draft the QDRO in a way that specifies this request.
Please note that the beneficiary that has received the funds into their retirement account must comply with IRS rules regarding retirement accounts following the transfer. In other words, if the beneficiary took the money out in later years, those distributions would be taxed based on their income tax rate. Once retired, the beneficiary would also need to comply with the required minimum distribution (RMD) rules. The IRS rules stipulate that a minimum amount needs to be withdrawn from a person’s retirement accounts each year.
QDRO and Taxes
A spouse or former spouse who receives QDRO benefits from a retirement plan reports the payments received as if he or she were a plan participant. The spouse or former spouse is allocated a share of the participant’s cost (investment in the contract) equal to the cost times a fraction.
A QDRO distribution paid to a dependent or child is taxed to the plan participant. If the former spouse who receives the QDRO benefit distributes the money into a non-IRA account, income taxes will be levied on those funds. However, there will be no early withdrawal penalty if the beneficiary is under the age of 59½.
The former spouse and beneficiary of the retirement assets also has the option to roll over the funds into a qualified retirement plan, in which case there will be no taxes applied. A rollover is merely a transfer of retirement funds from one retirement account to another. However, it’s important that the rollover paperwork be done properly. If the money is distributed to the beneficiary and the funds are not re-deposited into an IRA, there will be tax implications.
A trustee-to-trustee transfer is typically the safest way to transfer retirement funds from one retirement account to another. A trustee-to-trustee transfer doesn’t involve the beneficiary handling the money; but instead, the funds are transferred between the two financial institutions of the participant’s retirement plan and the beneficiary’s retirement account. Please note that it’s important to review with the plan administrator the process of a rollover into the beneficiary’s IRA before conducting the transfer.
Beneficiaries receiving retirement funds as a result of a QDRO must consider the additional assets when calculating their required minimum distribution in retirement.
Example of a QDRO
David and Kristen have been married for 15 years and have agreed to file for divorce. David currently has $200,000 in his 401(k) retirement plan, of which $50,000 was in the plan before their marriage.
During the divorce proceedings, both parties agreed on the assets that need to be divided amongst them, including the 401(k). The court-ordered QDRO was drafted by a divorce attorney and submitted to David’s retirement plan administrator. The plan administrator approved the QDRO, which has the following terms:
- David keeps $50,000 that was in his 401(k) before the marriage.
- The remaining $150,000 in the 401(k) Will be split evenly between David and Kristen since those funds are considered a marital asset.
- Kristen can withdraw $75,000 from David’s 401(k) and roll those funds over into another retirement account in Kristen’s name.
Who Files the QDRO in a Divorce?
Although some retirement plan administrators have their own form, a QDRO is usually drafted by a lawyer at the request of the beneficiary spouse.
How Does a QDRO Work?
A qualified domestic relations order (QDRO) is a court order or legal decree requiring that an amount or percentage of a participant’s retirement plan be assigned to another person. The person who is assigned the benefits is called the alternate payee and can be a dependent, such as a child or an ex-spouse, as in the case of a divorce.
For example, a QDRO might assign 50% of the value of a retirement plan to the alternate payee. As a result, the portion of the funds could be transferred to another retirement account in the name of the beneficiary spouse or dependent.
What Is a QDRO Used For?
A QDRO is often used during divorce settlements in which the couple’s assets are divided amongst each other. A QDRO is needed to split or assign the assets within a retirement plan. In other words, the company managing the retirement plan—called the plan administrator—can’t automatically split the funds owned by the participant to pay the ex-spouse following a divorce. In this sense, the QDRO is beneficial since it outlines specifically the amount or percentage of the assets that should be assigned to the ex-spouse.
Is a QDRO Required in a Divorce?
Federal law does not require that a QDRO be in place in the case of a divorce settlement. It is up to the parties involved to determine whether a QDRO should be drafted.
Are Distributions From a QDRO Taxable?
If the ex-spouse receives a QDRO benefit that distribution is transferred to a non-IRA account, those funds will be considered a taxable distribution. However, if the funds are transferred into another retirement account, no taxes will be levied by the IRS.
The Bottom Line
For those who are in the process of a divorce or will be divorcing soon, and the spouse or ex-spouse has a retirement plan, it’s important to consult a lawyer so that a QDRO can be drafted. While filing a QDRO appears straightforward, it can be challenging to remember during an emotionally charged divorce, especially if retirement is years or decades away.
A QDRO won’t automatically be created during a divorce, even if the participant has a considerable amount of money in their retirement account. If you’re representing yourself, notify the court that your spouse earned a retirement benefit to include the benefit when dividing the property. Also, the QDRO benefits can be used by the ex-spouse for housing to pay for a new home or the cost of housing expenses.