Even though they can remain inaccessible for the immediate future, pensions and retirement accounts may be the most substantial assets that separating spouses have. Therefore, couples on the verge of divorce in Alabama should consider how these retirement assets are covered under Alabama’s family law and their allocation in a divorce.
The rules on dividing retirement assets may be complicated and depend on whether the account is an individual retirement account, 401(k), a pension or other type of account. Dividing these assets may also have unintended tax consequences.
What does a QDRO do?
A qualified domestic relations order, or QDRO, is required to transfer certain retirement assets such as a 401(k) account or a pension. A QDRO is typically issued by a court and confirms a divorcing spouse’s right to receive all or part of the account owner’s defined contribution plan or pension.
A QDRO may divide plan assets in two ways. First, a separate interest in the account balance is awarded. The second gives the divorcing spouse the ability to share in the payment of its benefits. After court approval, a QDRO is then transmitted to the plan administrator for their approval.
Pensions and 401(k)s
Dividing pensions is complex. Each employer have their own rules on whether or how a pension is divided. The pension’s present value should be calculated by an actuary. The QDRO also makes it easier to divide a pension after a retired spouse started receiving benefits. The QDRO may divide the payments by a dollar or percentage amount.
A 401(k) is comparatively easier to divide because its value is clear and easier to divide. There are no tax consequences if the spouse receiving a share of the 401(k) transfers it directly into their IRA. A spouse that pockets the funds instead of transferring them into an IRA must pay tax on that amount. But there is no 10 percent penalty for early withdrawal, even if the recipient is under 59½. If the funds are transferred to the recipient spouse’s IRA and that spouse takes an early withdrawal, these funds are taxed and there is a 10 percent withdrawal penalty.