Avoid unnecessary taxes and penalties by using a Qualified Domestic Relations Order when splitting retirement account assets in a divorce.
Asset loss is a serious issue for divorcing couples in Brooklyn, New York. This can come in many forms such as the sale of a family home, the payment of spousal support and more. While the financial impact of a divorce is real and some of it is unavoidable, there are ways to minimize some of these losses. A primary way to do this is by utilizing the power of a QDRO when a retirement account must be split.
How hard can splitting a retirement account be?
It may seem logical that if a divorce decree indicates one spouse is to receive a certain portion of the other spouse's retirement account, a simple transfer of funds is all that is needed. That could not be further from the truth. One man who did just this after a family court judge instructed him to do so found himself facing a tax bill of approximately $5,000. Forbes notes this is because the man failed to file a Qualified Domestic Relations Order.
How can such tax bills be avoided?
The recommendation of a judge and even a signed divorce settlement is not enough to avoid taxes if retirement money must be used for any purpose related to a divorce. A QDRO is an essential component to such transactions for many types of retirement accounts. The U.S. Department of Labor explains that it can be useful when spouses must take money from a 401(k) or other similar account in order to pay child support, spousal support or their portion of a property settlement.
A QDRO works by identifying the receiving party as a legally approved payee on the retirement account. Once this is done, the provisions as outlined can be executed, transferring money to the recipient sans tax implications. The Internal Revenue Service adds, however, that there is one qualification to this when the money is distributed as part of a property division settlement.
Funds received for this purpose must be reinvested by the recipient in order to avoid tax assessments. Such reinvestment must be into similar retirement accounts that meet the legal criteria. Funds received for child support or alimony would not be subject to this rule.
Get the facts first
Before assuming anything, New York spouses facing a divorce should talk to an attorney. There are many small details involved in a divorce, such as how a QDRO can or should be used to avoid extra taxes, that most people will not know about on their own.