How can you and your soon-to-be-former spouse split your individual qualified retirement savings, frequently the largest asset you may each own, through careful and appropriate divorce planning?
With the collaborative and qualified guidance of a divorce financial planner, tax professional, and family law attorney, you can become fully acquainted with the following common Qualified Domestic Relations Order (QDRO) mistakes to avoid and ultimately ensure that your post-divorce retirement funds, including 401(k) and 403(b) plans, are prudently divided:
Not gathering all essential documentation on qualified plans can deter the process of dividing retirement assets
- Foremost, understand that the QDRO is an intricate and significant legal document, utilized to divide qualified retirement accounts pursuant to a divorce. Do not try to draft a QDRO on your own and consult with an experienced financial planner to identify retirement assets as qualified or nonqualified, as well as to delineate how a retirement plan is split in advance. Without a completely drafted QDRO, realize that the timing of cash distributions and/or transfers can be delayed and affect your cash flow.
- Ascertain that your QDRO documentations have specified that you are the plan participant and that your former spouse will be the alternate payee entitled to receive a part of the account balance or benefit in the plan. Verify that your QDRO conforms to provisions established under your state’s domestic relations laws and names each qualified retirement plan to be split up under your divorce. In addition, quantify the dollar amount or percentage of benefits to be paid from each of your qualified retirement accounts to the alternate payee, and detail the number of payments or benefits covered by the QDRO. The alternate payee would have no right to your divided death benefits, if these stipulations are not addressed in your QDRO.
Most pivotally, recognize that a QDRO cannot force distributions that are not allowed under the terms of your employer’s plan. To prevent potential QDRO mistakes, ensure sufficient discovery of different qualified retirement plan features by asking questions to your plan administrator prior to drafting the QDRO. Also, seek the support and direction of a divorce financial planner and legal professional for any concerns on how benefits are distributed out of your retirement plan.
Lack of understanding of the proper transfer mechanism of retirement plan funds
- Receive counseling from a seasoned certified public accountant, financial planner, and divorce attorney to become well-versed on the application of the rollover mechanism and possible tax implications of retirement plan distributions under a QDRO. Learn that your former spouse may have a legal right to receive a designated percentage of retirement plan money in a QDRO, and will be responsible for paying the associated income taxes when your money is received in the form of a future annuity, pension, or withdrawal.
- Do a trustee-to-trustee transfer under your QDRO arrangement to permit your former spouse to subsequently withdraw and rollover rationed money into an Individual Retirement Account (IRA). Note that your former spouse should be wary of setting aside any money from a QDRO plan distribution essential for estimated expenses (i.e. early withdrawal penalties for taking money out of an IRA to pay debts) before rolling the remaining distributions from a QDRO directly into an IRA.
When taking distributions from your retirement plan, be cognizant of selecting the appropriate qualified plan assets relative to your liquidity needs. Keep your future cash needs in mind and allocate your qualified plan funds accordingly.
Not monitoring and revising the beneficiary designations on retirement accounts
- Most importantly, after the QDRO has split the retirement funds, update your beneficiary form and designations according to your divorce settlement and estate planning wishes. In addition, monitor your post-divorce retirement plan beneficiary form to ensure your former spouse does not inadvertently receive remaining account balances at your death.
- Expeditiously, account for life-changing events, such as remarriage and immediate family member deaths, and revise retirement account beneficiaries in coordination with your state law.
After perusing these common QDRO mistakes to avoid, you should make a concerted effort to specifically define all encompassing issues of your post-divorce retirement plan. Involve an expert neutral financial planner and allied divorce professionals to address significant QDRO concerns and help plan a financial strategy that will enhance the transition to the next stage of your life.
FPA member Elaine King, CFP®, CDFA™, is the Author of Family & Money Matters. FPA member Philip Herzberg, CFP®, MSF, is Director of Media Relations & Public Awareness for FPA of Miami-Dade.