Your 401k might be your most significant and complicated marital asset, especially if you’ve been married for quite some time and have been contributing to it consistently. That makes it marital property, just like a home you buy together. You can sell your home or refinance it to buy out your spouse’s equity without the approval of anyone but the court, but with a pension plan such as a 401k, your plan’s administrator becomes involved.
Qualified Domestic Relations Orders
Legally splitting a 401k is a three-step process. First, your divorce decree must order the division. Next, you or your attorney must draw up a second legal document called a qualified domestic relations order, commonly known as a QDRO. This order tells the administrator of your 401k how to divide it to comply with the Employee Retirement Income Security Act, or ERISA, passed by the federal government in 1974. The family court judge must approve and sign the QDRO, then the plan administrator must also approve it, because the administrator is liable to the federal government if the order lacks in any respect. The QDRO establishes your spouse as an “alternate payee,” an individual other than you who can receive payment from your 401k.
Your spouse has three options for collecting her portion of your 401k. The QDRO must detail the method she chooses and direct the plan administrator how she wants to go about the process. She can roll the proceeds over into her own retirement plan or leave her share intact with yours in the existing plan, taking her payments when you retire. She can also elect to take the money as a cash payment.
According to IRS regulation (72)(t)(2)(C), your spouse’s chance to take her portion of your 401k in cash is a one-time deal at the time your plan administrator approves the QDRO. Beyond this point, unless she is over the age of 59½, she is subject to a 10 percent penalty for the early withdrawal. Regardless of her age, the IRS will usually treat the distribution as regular income to her when she cashes in, so she would be liable for income tax on the amount.
The timing of a QDRO can be critical. Unless one of you creates and files it when your divorce is final, your spouse’s interest in your 401k is vulnerable until this is accomplished. Your divorce decree alone isn’t enough to split up your plan. If you should die or retire before the plan administrator approves and implements the QDRO, your spouse would most likely lose her benefits. If you are the spouse receiving the benefits, it's important that you or your attorney prepare and file the QDRO as soon as possible.