Seeking a share of an ex-spouse’s 401(k) can be thorny
The breakup of a marriage is never easy, but for Maria Johns, the acrimony has extended more than a year past her divorce date.
Johns, a Florida resident, was officially divorced from her husband in July 2007. But the two are still wrangling in a Tennessee court over a qualified domestic relations order, or QDRO. It is the court order that awards a portion of a 401(k) retirement account to an ex-spouse. Paperwork has been signed but not received, and at last count, two drafts of Johns’ QDRO were winding their way through the courts. The proceedings have been an expensive proposition for Johns, who had let her original attorney go immediately after her divorce became final.
“I had to hire another attorney at full rate to handle this,” Johns says. “I had to pay a $5,000 retainer just to have him look at this and respond.”
The process of obtaining a qualified domestic relations order is part of the Employee Retirement Income Security Act of 1974 and is aimed at awarding part of a 401(k) account, pension plan or some other qualified retirement plan to someone other than the account holder, most often an ex-spouse. The legal action, completed with the court order, seems simple, but as Johns learned, things don’t always go smoothly.
Here’s what you need to know before getting started.
You may not need a QDRO
If you and your soon-to-be-ex both have retirement accounts with approximately the same value, it may be easier for you to just walk away with your own account and skip the QDRO process, says Dennis De Kok, a certified financial divorce practitioner with Family Capital Management in Grand Rapids, Mich.
However, De Kok warns, don’t make the mistake of giving your spouse a $50,000 bank account while you only take your own $50,000 retirement account. Early withdrawal penalties and taxes would significantly whittle down your 401(k) balance if you liquidate it today, while a checking, savings or other cash account is worth its face value immediately. “It’s really an inequitable settlement,” De Kok says.
Dot your i’s, cross your t’s
Every company that administers retirement plans has different rules about what must be included in a qualified domestic relations order. So make sure whoever is drafting yours is aware of them. In most cases, this will be your divorce attorney. Most companies have a boilerplate document they’ll send upon request.
“Everyone has their rules,” De Kok says. “If you don’t check with them, they may reject it because this name wasn’t in there or that phrase wasn’t included. That causes delays upon delays.”
Keep an eye on the balance
If you’re the nonemployee spouse, make sure that your attorney asks for past statements of your ex’s retirement account from the past three to five years and continues to receive them while the divorce is pending, says Gabriel Cheong, a family-law attorney in Quincy, Mass. If you know how much money is in the account, you’ll be able to easily detect any unauthorized withdrawals, transfers or other changes that are prohibited while a divorce is in the works. If your spouse does manage to remove some money anyway, Cheong says, those funds aren’t always lost. The qualified domestic relations order could be written to award you a larger portion of the 401(k), or you could even get half of whatever asset the purloined money bought.
“If your spouse takes money from the 401(k) and puts money down on a house, half of that new house could rightfully belong to the other spouse,” Cheong says. Divorce laws vary by state, so consult your attorney about the remedies available to you.
Stop making contributions
If you’re involved in a court action to obtain a QDRO and still putting money into a 401(k), you may want to stop making contributions while your divorce is pending. Because money that hasn’t been added to the 401(k) usually isn’t considered part of the marital estate, it should be acceptable to stop adding money to the account. However, check with your attorney before making the change.
“If your company matches that money, you’re giving some of it to your soon-to-be-ex-spouse,” Cheong says. “It’s a far better use of your money to not contribute at this point.”
Don’t wait until your divorce decree is final to begin working on your qualified domestic relations order. Not only will you save time, but you’ll eliminate the impact of any catastrophes that happen after the divorce is complete. For example, if your ex remarries after the divorce and names his or her new spouse as the beneficiary of the 401(k), you could be left without any claim to the account if your ex dies before the order is ratified.
“To avoid this nightmare, draft the QDRO before the divorce and enter it in court at the same time as the divorce decree,” says Denisa Tova, a certified divorce financial analyst with the Divorce Resource Centre of Colorado. Looking back on her experience, Johns says she wishes she would have followed that advice.
“Have all the paperwork signed before you ever go to court to finalize the divorce,” she says.
Re-invest the money wisely
Once the QDRO is done and the money is split, the nonemployee spouse will have his or her own 401(k) account managed by the same company that manages the ex-spouse’s account.
Still, it’s not always best to leave your money in the 401(k). You won’t get matching contributions that your ex does, and the investment options are usually limited to just a few mutual funds. Cheong advises rolling the money into a qualified retirement account, such as an IRA, or individual retirement account.
“You’ll have the whole market to play with and have all the different investment vehicles at your hand,” Cheong says.
Be sure to have the money sent directly from the 401(k) to the company that manages your new IRA. Withdrawing the money yourself and placing it in an account could leave you on the hook for a 10-percent penalty, plus income tax on the money that’s removed.
If you know you’re going to need money from the 401(k) to settle post-divorce debts, a little planning may help you get some of those fees waived. “The 10 percent penalty for withdrawal from the 401(k) can be eliminated if you write it into the QDRO,” De Kok says. “That can be extremely valuable.” But you’ll still pay income tax on the money that’s withdrawn.
When done properly, qualified domestic relations orders don’t take much time to complete. The wait time is usually 45 to 60 days, De Kok says. So Johns, whose divorce is more than a year old, is understandably frustrated that her QDRO is still in legal purgatory. Between hiring a new attorney and traveling to another state for court, the process has been bothersome for her.
“It’s just taken up a lot of my personal time,” Johns says.