Some Pennsylvania residents begin the divorce process thinking something along the lines of, “Well, I’m not rich, so property division shouldn’t be too hard,” only to eat their words later on.
Certain types of assets are harder to divide than others. Even if you don’t have a lot of assets, you may have a tough time if you have certain types of complex assets. And some of these assets may be more common than you think.
Retirement accounts in divorce
One such complex asset is a 401(k) retirement account. These are commonly offered by employers as benefits to their employees, and some sources state that 60 million Americans contribute to a 401(k).
The basic principle behind a 401(k) is that the owner contributes money to the account during their working life, to be withdrawn after they retire. The account increases in value over time, but the owner will face no taxes on these gains as long as they wait until after retirement to withdraw.
However, if an owner divorces before retirement, they will likely have to divide the 401(k) as part of their property division. If they simply withdraw from the account at that time, they will face taxes and other penalties that will greatly reduce the account’s value, leaving both former spouses without crucial funds for their retirements.
The most common way around this problem is through something known as a Qualified Domestic Relations Order, or QDRO. This is a type of court order instructing a financial institution to divide a retirement account without incurring taxes and other penalties.
A court can use a QDRO to reach into an otherwise-protected account for the purposes of collecting money for certain purposes, such as for a court judgment or unpaid child support.
In a divorce case involving a 401(k), the court will instruct the financial institution to divide the assets in the account according to the terms of the divorce judgment or settlement, with part of the money remaining in the account for the original owner and part going to their soon-to-be ex-spouse.
There are several ways a QDRO can arrange for this payment. One is known as a separate interest arrangement. In this type of action, the soon-to-be ex receives their share of the account in the form of their own new account. This may be another 401(k), an IRA or another type of retirement account.
In this way, both spouses can keep the benefits of tax-free accounts to fund their retirements.