Spouses thinking about divorce typically have a lot of questions about the process ahead. They aren’t sure about their rights or obligations. They may worry about the cost involved and the impact of dividing their assets. People want to retain their most valuable property, but asset division rules require that they split their resources and their financial obligations as part of their divorce proceedings.
Resources that are worth more money and that influence future financial stability are often priority considerations during divorces. Spouses may focus on their small businesses or the marital home. For others, retirement savings are a priority. People don’t want to give up the resources that they have set aside for their comfort later in life.
They may also worry that dividing a tax-deferred retirement account, such as a 401(k), could result in income tax consequences and financial penalties. Is it necessary for divorcing couples to divide retirement savings accounts?
Account division isn’t always necessary
Spouses theoretically have the option of working together and prioritizing specific goals as they settle their disagreements related to an upcoming divorce. In cases where both spouses may have put money aside for retirement, they might agree to each retain their own account and then use other property to balance out the difference in savings.
One spouse might give up their interests in the other’s 401(k) in return for retaining other property, such as a motor vehicle. Divorcing couples can frequently work out arrangements that allow one of them to retain their 401(k) without dividing it.
Penalty-free account division is possible
Sometimes, spouses cannot negotiate an arrangement that allows for one of them to retain the account while fairly compensating the other. Other times, a judge handling litigated property division matters may order the division of the account. In either case, it may be possible to avoid tax consequences and penalties when splitting a retirement account.
The use of a qualified domestic relations order (QDRO) can facilitate the pre-retirement division of a tax-deferred retirement savings account. A lawyer drafts the document, and both spouses have to sign it. After they submit it to the professional managing the retirement funds, the professional can withdraw a portion of the account balance to fund a separate account for the other spouse.
The proper execution of a QDRO eliminates the 10% penalty and tax consequences associated with premature account withdrawals. It is possible to retire comfortably even after divorce, especially if people are conscientious about preserving their resources.
