If you hear the term QDRO, you’ll know that you’re a full-fledged grown-up.
It’s an abbreviation sometimes uttered by a judge in a divorce court, or perhaps your attorney will bring it up. QDRO stands for qualified domestic relations order. To learn more about QDROs, read on.
What Is a QDRO?
A QDRO is a court order that judges use to split up certain types of retirement plans, like a 401(k), into two equal parts for a divorcing couple. Not every retirement plan, however. For instance, a legal order called a “transfer incident to divorce” will carve up an IRA, or individual retirement plan.
You’ll usually need to get a QDRO if you and your spouse share the following financial retirement plans:
— A private pension plan.
— A 401(k) plan.
— A 403(b) plan.
— A 457 plan.
— Employee stock ownership plans (known as ESOPs).
— A defined benefit plan.
Generally, a QDRO is created to make sure both parties in a couple get equal shares of money from the retirement benefits they’ve accumulated throughout their marriage.
That said, sometimes in a contentious divorce, the court will designate half of the retirement assets to go toward alimony or child support if one member of the couple can’t fulfill their financial obligations or isn’t attempting to. But if that isn’t your case, and with any luck, you’ll each get half of the retirement benefits.
How Much Does It Cost to Prepare a QDRO?
It all depends on your retirement portfolio, assets and so on. Generally, a QDRO can run a few hundred dollars on the low side and into the low thousands, like $2,000, on the higher end. Frequently, your divorce attorney won’t actually prepare the QDRO; it will be done by an actuary or a company that specializes in putting together QDROs. But your divorce or family law attorney can put you in touch with a professional who does that work.
Benefits of a QDRO
There are a few reasons to consider creating a QDRO. They include:
Fairness. One of you may have earned most or all of the money, but the other presumably also did their part raising the kids or pets and keeping the household together. In most cases, you both probably have a good argument for getting half of your retirement assets.
Less stress down the road. Talking about a QDRO may not be your idea of a good time, but it’s far better to have these discussions now rather than later. “QDROs are important because they help to avoid conflict over the division of property oftentimes years or decades after a divorce,” says Stephen Cawelti, divorce attorney and owner of Cawelti Law in Los Angeles. “Too often, couples enter their divorce judgment and then forget to do the QDRO, which is a separate order that just applies to the retirement asset.”
Look at it this way: You may or may not think the world of your soon-to-be ex right now, but — especially if you have children — you’re going to want an amicable relationship going forward. If you don’t have a QDRO, you or your ex-spouse may come to regret not getting one. If you’re the one with the lion’s share of the retirement assets, your ex could regret it so much that you’re invited to discuss your retirement assets in court.
If you’re the one who doesn’t have many assets, meanwhile, that either means you could have a future retirement in which you struggle, or you someday decide you need to fight this in court, which means you’ll have to hire an expensive attorney at a time when you may not have much money.
In short, getting a QDRO now can help ensure that you and your ex both have retirement affairs in order and a healthy relationship in the future.
Fewer tax problems. Potentially there will be fewer taxes that you and your ex may end up paying in the long run if you set up a QDRO now.
“Normally, money removed from a qualified plan is taxed at ordinary income rates and could be subject to a 10% penalty as well,” says Beth Logan, an enrolled agent and owner of Kozlog Tax Advisors in Chelmsford, Massachusetts.
Financial certainty. Maybe you and your ex get along pretty well. Not enough to stay married but well enough that you see no future problems after the divorce. So you both agree that you don’t need to “waste” money putting together a QDRO, and you’ll split the money down the road when you both retire.
That’s a bad idea. For instance, what if your ex remarries and dies, and your ex’s new spouse doesn’t think you deserve any of that money?
Even if things don’t work out that way, you could have problems if your name isn’t on these retirement accounts as a beneficiary. Many financial institutions simply won’t release the funds to you unless there’s a QDRO in place. And even if things work out well, one or both of you may find out there are tax consequences because you didn’t set up a QDRO. Sure, it costs money to set up a QDRO, but it can also cost money if you don’t set up one.
How Does a QDRO Work?
“The QDRO allows the money to be moved from the account holder’s qualified retirement plan account to the spouse’s retirement account without any taxes due until the money is distributed later,” Logan says. “If the spouse wants the money as cash — not as part of their retirement — or moved to a Roth IRA, then the spouse will have to pay the taxes on the money. The QDRO will eliminate the 10% penalty for the withdrawal.”
That can be a helpful thing, too, if you feel you can afford to take that cash from your future retirement. You may need the money as cash to, say, buy a house after a divorce, and not having to pay a 10% penalty is something that comes courtesy of the QDRO.
How Does a QDRO Work in a Divorce?
As for the mechanics of how this works, one of you should contact your attorney, who will write up a QDRO document, or more likely, introduce you to a professional that specializes in drawing these up.
Once that’s finalized, the QDRO document will be submitted to the retirement plan administrator, who will then review it and, if all looks fine, send it to the court.
[Read: Cost Breakdown of a Divorce.]
Who Is Responsible for Filing a QDRO?
In the technical sense, after the QDRO document has been created, the retirement plan administrator will file it with the court. So you don’t have to worry about that.
Still, if you are the spouse who will be receiving the QDRO benefits, you may want to pay particular attention to whether the QDRO is being set up. You may be divorcing somebody who is kind and generous and wants everything to work out well for you — but still may forget to talk to an attorney or tax advisor about the QDRO. So if you’re the beneficiary, you should make sure the QDRO is getting prepared — but once it’s actually time to file it with the court, that is generally done by a retirement plan administrator.
And, of course, if you think your soon-to-be ex doesn’t have your best interests at heart, you don’t want to put this task in their inbox. You’ll want to make sure the QDRO is being set up and then filed.
You’ll also want to file the QDRO early in the divorce proceedings. If you wait until the last minute, for all you know, your spouse could invest your retirement income into something risky or withdraw the money and spend it. It’s best to have this nailed down as soon as possible.
How to File a QDRO
The main rule here: Don’t do it yourself. Hire somebody who specializes in this sort of thing.
“Unless you’re a serious DIYer with nothing but time on your hands, it is not something I would ever advise someone to attempt on their own,” Cawelti says, adding that it can take months or even years to put these together, especially if you’re doing it yourself.
There’s a lot to filing a QDRO. Some things are easy enough. For instance, you’ll need to have the full name, mailing address and Social Security number of you and your soon-to-be ex, who will probably be referred to in the paperwork as the “alternate payee.” But if you were to draft a QDRO yourself, would you know to make sure that it adhered to Employee Retirement Income Security Act guidelines? This is why it’s best to leave it to the professionals.
Kellie Rahl-Heffner, a family law attorney at Gross McGinley LLP, in Allentown, Pennsylvania, paints quite a picture of how many steps there are after the QDRO is put together, let alone putting it together.
“Once the QDRO is drafted, it must be signed by all parties and taken before the judge for signature making it a court order. That order is then sent to the retirement plan administrator for processing. They will divert the enumerated funds to the alternate participant’s account,” she says.
Logan also stresses that the QDRO should be reviewed by the plan administrator before the divorce is finalized. “A QDRO that violates the retirement plan’s terms is not valid,” she says.
For instance, Logan says that if you have the QDRO stating the beneficiary will receive a lump sum payment from a pension, but the pension plan prohibits lump sum payments, that’s a big problem. “The spouse will end up with nothing,” Logan says.
That’s another reason not to draft a QDRO yourself and why your spouse shouldn’t do it. The stakes are just too high.
How Is a QDRO Paid Out?
In a way that’s the wrong question. “A QDRO is not a payout, it’s just a formal way to divide the retirement account so that the IRS doesn’t impose in income tax or penalty,” says Patrick Simasko, an elder law attorney and financial advisor at Simasko Law in Mount Clemens, Michigan.
Still, if you’re the recipient — that is, if the retirement funds are in your soon-to-be ex’s name — you’re wondering how you’re going to get your money from the QDRO. And, well, you have a few options.
Do you want all of the money you are entitled to, all at once? That sounds great, and it may be, but you probably will end up paying taxes on it at the outset, unless you put the money into another retirement account of your own. You’ll want to talk to a tax professional first.
You could receive the payments as an annuity and receive the money in installments. From a tax standpoint, that may be better.
You also could choose to let the money sit in the QDRO 401(k) or other retirement plan, so the money can keep growing tax-deferred until either of you need to take it out.
Again, it’s best to discuss all of these strategies with a tax professional. And if you opt for the money to stay put in the retirement accounts, you’d want to set up the QDRO so you would be free to invest your portion of the money however you see fit.
Do I Need a QDRO to Split a 401(k)?
You do need a QDRO to split a 401(k), says Rob Burnette, CEO, financial advisor and professional tax preparer at Outlook Financial Center in Troy, Ohio.
You also need to make sure it’s set up properly, Burnette says. Otherwise, the person receiving the money could be hit by taxes.
“Having the QDRO alone isn’t enough. To avoid paying taxes by the plan participant, the QDRO must list the receiving spouse as an alternate payee and meet specific provisions. Otherwise, the distribution to the former spouse could be fully taxable to the plan participant as a distribution,” he says.
Can I Cash Out a QDRO?
Yes, you can, though if you take the retirement money as cash to do what you like, rather than put it in a new retirement vehicle, you will likely quickly lose some of that money to taxes — about 20% will go to estimated taxes, though you may ultimately get some of that back.
“The distribution is taxable to the recipient spouse but are not subject to early withdrawal penalties,” Burnette says.
Simasko agrees that after the QDRO is set up, you can promptly cash it out.
“Once the 401(k) plan or other retirement account is divided in accordance with the QDRO, then each party owns their individual account, and they can do with it as they please. So, if one party receives their share of the retirement account and they want to cash it out, they can,” Simasko says.
What Happens if a QDRO Is Not Filed?
You really don’t want to find out, especially if you’re the one holding the retirement account. If you don’t fill out a QDRO, and then you later divvy up your retirement assets and give them to your ex-spouse, you will be the one who ends up owing the Internal Revenue Service.
“In this case, the plan participant will be on the hook for paying income tax on the funds transferred to the former spouse,” Burnette says. “Tax court rulings in this matter have said distributions without a properly executed QDRO were taxable to the plan participant even though the former spouse received the money.”
Do I Need a QDRO?
It really depends what you and your spouse have to split. If you one of you has a retirement account that contains, say, $600, you may feel like it isn’t worth fighting over that. Or if each of your retirement accounts contain similar amounts, you may feel it isn’t important to do a QDRO. Still, check with your attorney and see what they say.
If one of you has considerable assets saved for retirement in your name and the other spouse doesn’t, and assuming that this money was saved during your marriage (and not, say, for many years before your marriage), then it’s hard to make an argument that you don’t both need a QDRO. And that is as good a reason as any to prepare a QDRO — to avoid a lot of heated arguments in the future.
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Update 09/06/22: This story was previously published at an earlier date and has been updated with new information.