As part of a divorce settlement, marital assets are often split. This typically includes retirement accounts, such as 401(k) plans. Normally, 401(k) balances cannot be accessed before retirement or a separation from service, and they cannot be rolled over to a name other than that of the original account holder. A court order known as a qualified domestic relations order, or QDRO, grants the legal permission to allow an ex-spouse to roll over 401(k) assets in the event of a divorce.
Rollover to Ex-Spouse's Accounts
A QDRO gives an ex-spouse the right to receive funds from a qualified retirement plan, like a 401(k). However, the beneficiary of the QDRO then has the responsibility of doing something with the funds. One option for the ex is to roll over the funds into his own individual retirement account . If the beneficiary spouse has an IRA, he is free to roll over those funds without any tax consequences or other penalties. If no IRA exists, the ex-spouse can open one for this purpose.
Although it's available as an option, probably the worst choice for an ex-spouse, financially speaking, is to take a cash distribution. Money withdrawn from a 401(k), even a QDRO-sanctioned divorce division, is fully taxable.
Direct vs. Indirect Rollover
When choosing to roll over QDRO assets, an ex-spouse can take a direct or an indirect rollover. If the ex-spouse requests a direct rollover, the 401(k) administrator will send the money directly to the receiving IRA account with no tax consequences. However, if the ex-spouse chooses an indirect rollover, she will receive a check and have only 60 days to complete the rollover. If the money doesn't find its way to an IRA by the deadline, the Internal Revenue Service will label it a failed rollover, and the taxes associated with a cash distribution will apply. Additionally, 20 percent of the indirect rollover will be withheld for taxes by the 401(k) administrator. To complete the rollover and avoid taxes, the receiving spouse will have to come up with that money from additional funds.
Keep in Original Spouse's Account
While it may seem counter to the idea of divorce, an ex-spouse may be able to keep his funds in the original 401(k) account. This can make sense in a number of situations, such as if the 401(k) offers good performance
Keeping the money in place also preserves the future right to withdraw the money without paying an early distribution penalty. For most withdrawals from retirement plans before age 59 1/2, the IRS levies a 10 percent tax. However, QDRO withdrawals are exempt from this penalty, whether taken immediately or at a future date. So, if an ex-spouse chooses to keep the money in the original 401(k), it can be taken out in the future without penalty. However, if those funds are rolled over into an IRA, that right is lost at the time of the rollover. Future withdrawals from the receiving IRA before age 59 1/2 will be subject to the 10 percent penalty.