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Top Tax Issues That Commonly Arise During A Divorce When It Is Time To Divide Your Retirement Benefits

Posted by Corey F. Schechter | May 17, 2017 | 0 Comments

Contributing Author: Dianne Schechter

If a couple has a joint investment in a retirement plan, such as a 401(k) or IRA and subsequently divorces, the plan account can be divided to give each spouse their fair share. To divide the plan account without either spouse incurring a massive penalty for early withdrawal from the account, the couple will need to have a Qualified Domestic Relations Order (QDRO) prepared.

A QDRO allows ownership in the plan to be transferred to an alternate payee, such as a former spouse or dependent child. Through a QDRO, property can be divided and alimony payments can be made. A QDRO is basically a legal order, due to a divorce or separation, that splits ownership of a retirement plan account in order to give each ex-spouse a fair share of the plan or assets.

If you are going through a divorce it is important to seek the professional advice of an experienced ERISA attorney if you will be affected by a Qualified Domestic Relations Order and to have them prepare that order for you.  Retirement benefits are generally governed by a complex federal law known as the Employee Retirement Income Security Act (ERISA).  Along with this, there are tax implications that you also need to be aware of. If you receive advice from an experienced ERISA attorney about your QDRO(s), and how they will change your tax situation, the better off you are going to be.

To be “Qualified” for this option, the plan must be a recognized pension or benefit plan under ERISA. After you bring your QDRO proposal to your state domestic relations court, the administrator of your plan will make a final determination that it complies with the requirements of ERISA.

With most QDROs, the person referred to as the alternate payee (the person who is not the account holder) is taxed when the funds are withdrawn from the account. It is important to note that the 10% early distribution penalty does not apply here when the funds are transferred between former spouses pursuant to a QDRO. If the spouse who receives part of the other spouse's plan account completes an IRA rollover within a 60-day window, tax on the amount transferred can be deferred.

However, before you act on this advice, note that this is only the case if you are a spouse ― not a dependent. Also note that the rollover must happen within 60 days of receipt of the funds from the QDRO. To ensure that you avoid the standard 20% federal income tax withholding, make sure the funds are directly transferred from the qualified plan to your IRA.

If you want to take full advantage of the tax-free transfer described above it is important that you use a QDRO to split any qualified retirement plans. Neglecting to do so could result in hefty penalties and tax charges, particularly for the Participant in the plan. It is also important to get professional legal advice to help you obtain the assets you deserve by way of a QDRO. To get proper legal advice regarding the division of your retirement benefits, you will want to hire an experienced ERISA attorney.

If you are going through a divorce and a Qualified Domestic Relations Order is likely needed in the future, make sure to seek advice from an experienced attorney before the settlement agreement is entered into. This will help to ensure that your assets are divided fairly and you do not incur any unnecessary taxes.

For any other questions concerning the division of your retirement benefits, call one of the experienced ERISA lawyers at Butterfield Schechter LLP at (858) 444 -2300 or click on our web site at www.bsllp.com for more information.

About the Author

Corey F. Schechter

Corey Schechter practices in the areas of Employee Benefits, Employee Stock Ownership Plans, Pension and Profit Sharing Plans, ERISA, ERISA Litigation, Business Law, Qualified Domestic Relations Orders (QDROs), and Employment and Labor Law.

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Retirement Plans

We help establish a customized plan that meets regulatory requirements as a tax qualified plan. Following implementation, our attorneys can assist clients and their plan administrator with regular reviews and updates to help with regulatory compliance for the plan's operation, and continued effectiveness in meeting the client's specific goals.

ESOPs

We are dedicated to employee ownership. When you come to us for ESOP services, you receive influential legal counsel who stand beside you to help you stay informed, in compliance, and abreast of the latest developments-all to help you realize your plan goals as fully and effectively as possible.

QDROs

A QDRO is a specially designed court order that is required for the division of retirement benefits in a family law case. Many family law attorneys do not possess the expertise necessary to divide retirement benefits or stock options upon divorce. We have extensive experience in dividing qualified plans, government plans, IRAs and stock options between the employee spouse and non-employee spouse.

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