Understanding the QDRO
As a CERTIFIED FINANCIAL PLANNER™ and a financial coach, I understand just about as well as anyone that life happens and that it's messy (forever). I see and interact with people who are in and out of different stages of life. However, before we start, let's go ahead and get something out of the way - today's topic, Q.D.R.O.'s, is very closely related to something that might be fairly uncomfortable for a lot of readers… divorce. I know, I know… great way to start an article, right? On a more serious note, while no one wants to talk about dark and uncomfortable things like death or divorce (or taxes), these topics are unavoidable. If you never ever ever get divorced, you're one of the lucky ones who's found their soulmate and gets to ride off into the sunset. Not all of us are that lucky. For some people, it takes a few tries to get the whole marriage thing just right.
You may be saying to yourself, "Hold on Melissa… you're talking a lot about divorce and not a lot about Q.D.R.O.'s." In just a few moments, you'll see why. So let's get into it. What is a Q.D.R.O.? What are they for? Who needs one and when?
What is a QDRO?
Have you ever noticed that many legal and finance terms are weird acronyms that professionals pronounce like a word? A Q.D.R.O., which many pronounce "quad-row," stands for qualified domestic relations order. When dissecting this term, it can be broken into two pieces "qualified order" and "domestic relations." This is where you may begin to see why I was rambling about divorce. The "domestic relations" portion of Q.D.R.O. refers to whom the qualified order applies.
A qualified domestic relations order is an order that is obtained by parties undergoing the divorce or separation process. Parties seek these orders from a judge to decide how to divvy up retirement plans that qualify and are subject to the Employee Retirement Income Security Act, or E.R.I.S.A. (please note that this is yet another acronym that is pronounced as a word). The Employee Retirement Income Security Act created minimum requirements for private companies' pension plans. E.R.I.S.A., and by extension, QDRO applies to pension and health plans. A QDRO can also apply to 401(k)s and 403(b)s. With a QDRO, a judge will give specific instructions of what dollar amount or percentage will be provided from one spouse to another over a particular length of time.
Why Would You Need (Or Not Need) a QDRO?
For the most part, only people who are splitting their assets because of divorce or separation would need a qualified domestic relations order. Further, you should really only need a QDRO if you or your spouse are splitting a retirement or pension plan that has contributed to during your marriage. While getting a QDRO might seem like a drag as part of a divorce, it could actually be viewed as a blessing in disguise. While dealing with the unfortunate reality of splitting marital assets, it also allows penalty-free withdrawal of the judge-specified amount.
Another point that is often misunderstood about QDRO's is that they aren't all-encompassing. Some are taken aback when they receive their QDRO, and it doesn't apply to every account they're attempting to split. You may be splitting multiple retirement accounts or pension plans. If that's the case, you'll need a QDRO that directly applies to each of those accounts. Depending on your state, judge, lawyer, and situation, you may require a QDRO that's individually specific to each plan you're splitting, or you may be able to receive a QDRO that specifies multiple accounts (in which case it would have to state that).
QDRO's are also not applicable to I.R.A.s, (also called Individual Retirement Accounts) which also comes as a shock to some. I.R.A.s are split and handled with using a decree and transfer paperwork. As long as it is appropriately labeled by you and your spouse, you should both be able to avoid penalties or taxes upon transferring. However, if one of you mislabels the transfer, both of you will run the risk of being charged taxes and penalties.
What's the Process of Getting a QDRO?
With all of these acronyms and jargon, it can be challenging to determine what you should actually be doing. So what is your first actionable step in the process of obtaining a QDRO? That’s kind of a trick question because for legal situations like this you should always consult a qualified attorney!
According to Pension Rights, you should hire a legal counsel that will handle the nuts and bolts of the situation for you. If you're opting to represent yourself in court, you should let the court know that you're representing yourself without a lawyer. After that, you should contact the plan and determine if you have a right as a prospective alternate payee to access the plan. Pension rights say the four things you should ask for if you're given access are:
They also say that if you run into any issues while attempting to gain access to the plan, you should contact the department of labor's employee benefits security administration, specifically the pension rights center.
Distribution of QDRO Payments
Typically, there are three options for the distribution of QDRO payments.
Keep in mind that distributions from pension plans or retirement plans can get complicated. Consult your legal counsel, financial professional and most importantly your tax advisor to understand the pros and cons before making any withdrawals. It would be extremely unfortunate to find yourself in a tax snafu after all the dust is settled.
1. The first option is to roll your assets into your own qualified retirement plan. This can be done with a direct transfer and shouldn't require immediate payment of taxes or early withdrawal penalties.
2. Secondly, you could put off taking the distribution until the account owner retires. With this option, you take out regular payments or withdrawal a lump sum. Something to keep in mind is that you'll be required to begin withdrawing minimum payments at 72 years old.
3. Lastly, you could withdrawal the balance. While this does give you the most immediate access to the money, you'll likely incur withdrawal penalties and be required to pay income tax unless you're at least 59 and a half years old.
At this point, it would be in your best interest to bring your financial planner or financial coach into the mix. With an overall picture of your finances, they should be able to help you determine which course of distribution will be best for you and your financial wellbeing. Remember that financial plans are not one size fits all, and should be tailored to your specific needs.
A Few Q.D.R.O. Facts and Essentials
Now, I thought I'd leave you with a few tidbits of information about QDRO's that I've picked up and may save you from making a mistake here or there! For starters, it's usually best to get your QDRO completed and before your divorce is finalized. Having access to this money may help you in the wake of incoming legal bills and fees. Local state laws also have a lot to do with how your plans will be divided. If you're unaware, laws change from state to state, and having a local lawyer who knows your state's ins and outs will behoove you. Courts and judges will consider multiple factors when deciding how to divide your or your spouse's plan. Some of those factors are your and your spouse's assets, income, ability to earn income, length of the marriage, and the specifics of your plan. If you and your spouse have a prenup, this could potentially complicate things, and it would be best for you to seek the counsel's legal advice.
A CERTIFIED FINANCIAL PLANNER™ Can Create a Comprehensive Financial Plan To Help You Incorporate a QDRO into Your Financial Plan
Divorce isn't something any of us want to deal with when we're getting married, and neither is dividing up all of our marital assets and accounts. If you're looking for a way to ease the burden of divorce or your finances while you're undergoing a divorce, please, feel free to call or email to schedule an appointment with me.
Until next time...this is Melissa Making Cents!
Melissa Anne Cox, CERTIFIED FINANCIAL PLANNER™, is also a College Planning and Student Loan Advisor and Financial Coach in Dallas, Texas.