During a divorce, retirement accounts are normally assets that are subject to division. Traditional ERISA pensions, 401(k)s and 457 accounts, Roth and traditional IRAs can be considered assets of the marriage. Separating persons in Colorado should be aware that these assets must be treated differently in a divorce or separation.
There are times when these assets do not need to be physically split between the parties. If there are other assets of the marriage that offset the division of a retirement account, another asset may be ‘traded” against the account.
Other times, an equitable division requires a full or partial division of a retirement account. For pensions, 401(k)s and other employer-sponsored accounts, a QDRO, or Qualified Domestic Relations Order is used. This is a separate court order dividing these assets. It is drafted pursuant to the terms of the employee’s retirement plan. The reason for using a QDRO is to ensure that the transfer of property from the plan participant to the spouse doesn’t create adverse tax consequences.
A traditional IRA must be treated a little differently than a QDRO. First, a separate QDRO is not necessary. Second, the transfer must be made a full or partial interest from the IRA-owning spouse to the nonparticipating one. Third, the transfer must be made within a divorce or separate maintenance instrument.
Normally, the divorce decree or a separation specifically incorporated into the decision by the judge will meet the last requirement. Failing to follow these requirements could be considered a transfer of property and subject the owner to a 10 percent early withdrawal penalty as it will be treated as ordinary income.
Divorcing persons not only seek representation by attorneys and accountants as advocates but to ensure that the transactions are handled properly. Failing to do so can cost a divorcing party thousands of dollars in penalties. As such, avoiding adverse tax consequences in many cases can be as important as the equitable division of assets.