Qualified Domestic Relations Orders (QDRO)

A QDRO is a legal document, signed by a judge, which divides someone's retirement accounts or benefits as part of a divorce. QDRO drafting can be done by a professional or a lawyer. In many marriages, the husband's and/or wife's pension or 401(k) is one of their most significant marital assets. Sometimes, it's the only asset of any real value. So, it will be important to handle the distribution of those retirement funds appropriately in the divorce action.

If either spouse accumulated retirement benefits during the course of the marriage, those benefits are generally considered marital property. Most states will consider unpaid retirement benefits accrued before marriage as non-marital or separate property (which is not subject to division in a divorce). Also not subject to division are social security benefits, federal "Tier I" railroad retirement benefits, some government pensions and, in some states, teachers' pension funds.

Everything else though will need to be part of the property distribution in a divorce. If a spouse has all of their retirement savings in Individual Retirement Accounts ("IRAs"), the former couple may not need a QDRO, although certain IRA custodians will require a QDRO. The parties should always check with the IRA custodian to verify their requirement for IRA division. If a QDRO is not required for the IRA, the administrator of the IRA will just need a copy of the divorce decree and the final settlement agreement if the parties reached one, which should include instructions to roll a certain amount or percentage into a new IRA for the other spouse. In some cases the IRA custodian will have the parties draft a Letter of Instruction to clarify the settlement agreement. The division of the IRA is a non-taxable transfer between former spouses, however if the receiving spouse takes a cash withdrawal from their share of the IRA, ordinary income taxes will apply as well as the 10% tax penalty, if the receiving spouse is under age 59-1/2.

If the parties are dealing with traditional pensions (also known as "defined benefit plans"), Employee Stock Option Plans (ESOPS) and 401(k) plans ("defined contribution plans"), the law and the plan administrator will require a QDRO in order to divide these plans.

Because federal law governs how pension and 401(k) plans are contributed to, administered, taxed and ultimately paid out, the law also has very detailed requirements for the division of a divorcing person's interest in those plans. Just as you can't just withdraw the money yourself without penalty and tax implications, you also can't split the funds with your new ex-spouse without the same implications. Unless, of course, you use a Qualified Domestic Relations Order or QDRO.

With a QDRO, all or a portion of the retirement funds in a pension plan or 401(k) plan can be transferred from the plan participant spouse to the other spouse (now known as the "alternate payee"). An appropriately drafted and signed QDRO will result in the establishment of a separate account for the receiving spouse. If the participant spouse has a traditional pension, the receiving spouse will have his or her own separate pension benefit established as a result of the QDRO. If the participant spouse has a 401(k) plan, the QDRO can authorize a tax free rollover of a portion of plan funds to the receiving spouse's IRA or other qualified plan under their name.

Sounds easy right? In fact, good QDROs are very detailed and must meet certain specific requirements. Those requirements might be statutory or they might be unique to a certain plan's administrator, as there is no "one-size" fits all QDRO. The plan administrator should approve the language of the QDRO before the judge signs off on the QDRO. There are some plan administrators who are very picky about QDRO language, and federal law gives the plan administrator the final say on what is an acceptable QDRO. If the QDRO doesn't meet certain legal requirements, though, the participant spouse could end up transferring retirement funds to his or her ex-spouse AND get stuck with a tax liability on those funds. Reviewing QDRO language with a fine tooth comb may be tedious but it is worth it in the end.

A typical divorce lawyer may or may not be skilled at QDRO drafting. QDRO preparation involving defined benefit plans (traditional pensions) can be especially complicated and time-consuming. Many attorneys then will actually outsource the drafting of the QDRO to a QDRO specialist - just so that the process is made more efficient and so that every IRS (and other) requirement is unquestionably met.