Many people have set up retirement accounts through their employers or on their own. These accounts come in many forms, but many grow in value tax-free so long as the owner is still working. When they reach retirement age, the owner can withdraw the funds without having to pay taxes on the money the account earned over the years.
If, on the other hand, the owner does withdraw money from the account before they reach retirement age, they can be hit with a substantial tax bill. They may also have to pay a fee for early withdrawal from the financial institution holding the account. These costs can greatly reduce the overall value of the account.
Retirement accounts can become quite valuable over the years, and they may represent a significant percentage of a married couple’s assets. This can lead to problems when a couple decides to divorce.
Equitable distribution
New York follows the “equitable distribution” model for property division in divorce. This means a married couple must divide their marital property in a way that meets state standards for fairness.
With few exceptions, anything — assets or debts — acquired during the marriage by either spouse is considered part of the marital property. This can include a retirement account, even if it is in the name of just one of the spouses. Even if the spouse started the account during the marriage, the marital property may include any value the account gained during the marriage.
Here’s where the big problem comes in: If you must divide your retirement account in divorce, how do you do so without incurring a big tax bill and other penalties?
QDRO
For some types of retirement accounts, the answer lies in a legal tool known as a Qualified Domestic Relations Order. A QDRO is a court order that instructs a financial institution to divide a retirement without triggering taxes or early withdrawal penalties.
When the financial institution divides the account according to the terms of the order, the primary owner of the account can carry on as before. The other spouse may keep their share in a new account with the same institution or may place the funds in another institution. In either case, this spouse will become responsible for the taxes on their share of the funds. They must be follow certain procedures to make sure their funds remain tax-free.
QDROs are generally used for 403(b) and 401(k) plans. Dividing IRAs requires a different type of process