Retirement plan benefits are frequently divided between husband and wife as part of divorce. The court order dividing a retirement plan is called a Qualified Domestic Relations Order or QDRO for short (QDRO is pronounced “quad-row”).
There are two basic types of QDROs – a separate interest QDRO and a stream of payment QDRO. The most common type is a separate interest QDRO.
A Separate Interest QDRO actually divides the employee’s (plan participant’s) interest in the retirement plan. A portion, or separate interest, is awarded to the spouse (called the alternate payee) and transferred into the spouse’s name. The separate interest QDRO results in a portion of the plan participant’s benefit being removed from the employee and assigned to the spouse. The advantage of a separate interest QDRO is that the alternate payee spouse can choose when to start receiving plan benefits and how they will be paid.
By way of contrast, a Stream of Payment QDRO is much less flexible for the non-employee spouse. This form of QDRO says that “when or if” the employee starts receiving pension payments, a portion of each payment will be paid to the former spouse by the plan instead of 100% being paid to the plan participant.
Either type of QDRO must be signed by the judge as a court order. The QDRO will be reviewed by the retirement plan administrator to make certain that the QDRO meets the requirements of the law. The plan administrator’s review also confirms that the language of the QDRO is consistent with the options available under the specific retirement plan. Most large employers have sample QDROs available from the plan administrator.
An IRA can be divided as part of the divorce without a QDRO. The receiving spouse’s portion can be rolled over into a pre-existing IRA or into a newly established IRA account. This rollover of all (or part) of an IRA requires less attorney work than a QDRO, but there are some advantages to dividing a qualified retirement plan instead of an IRA when you have a choice.
Distributions from both IRAs and Qualified Plans before age 59½ are called early withdrawals. Such early withdrawals are usually subject to a 10 percent income tax penalty. However, such a distribution under the terms of a QDRO to an alternate payee can be made without being subject to the penalty tax on early distributions. Consult with your tax advisor if you need to take a retirement plan distribution to make certain that you meet all of the requirements of I.R.C. § 72(t)(2)(C). If the QDRO distribution is rolled directly into an IRA, and the alternate payee then withdraws funds from that IRA before age 59½, the IRA distributions would be subject to the penalty tax.
Most often, if permitted by the retirement plan, keeping a separate account within the plan would be preferable for the payee spouse to rolling the spousal share over into an IRA. Certainly this is the case where the receiving spouse anticipates an early withdrawal. Many divorcing parties have both retirement accounts and IRAs. In dividing marital assets, such considerations can help determine whether the receiving spouse would rather receive a portion of a retirement plan under a QDRO or an award of IRA assets as part of the equitable division.
© Karen S. Hindson, Hindson & Melton LLC February 19, 2014