The War of the Roses - Rules on Splitting Pension Accounts

Divorce has three separate sections: (1) how you split the assets (2) how you split the income (3) custody of the minor children. I  recommend you go through each of these separately as divorce is an emotional and exhausting process.  

Splitting retirement assets is possible without incurring a penalty and/or income taxes. 

I have seen advice given suggesting that when splitting a 401k, the recipient spouse is responsible for paying taxes and penalties when receiving his or her share. This is only half the equation, and it misses an important financial planning step.

The purpose of a 401k or Individual Retirement Account is to allow you to defer paying taxes today.  The accounts also grow tax free and taxes aren't incurred until you retire (age 59 1/2 or later)  Once you begin taking the money from your retirement account you will then incur income taxes on the amount you take.  

Putting the money into a new retirement account will stop the penalty and defer the income taxes.  Using a QDRO is how you take advantage of this process.

In general, federal law provides that a retirement account may be divided in a divorce by a Qualified Domestic Relations Order, or QDRO, and thus avoid the taxes and penalties. A QDRO works by allowing the retirement plan administration to carve out the spouse's portion and allow it to be moved into a retirement account in the name of the spouse.  

However, if the spouse decides that they're not going to move the money into their own retirement account but instead take it out and spend it, then they usually will incur the tax penalty and  pay income taxes.

The QDRO is a legal document as is the pension plan so don't do this alone.  If not done correctly it may not be enforceable or accepted by the IRS. 

At BMM, we will work with you and your divorce attorney to assist in the financial planning of this process.  

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