Understanding Divorce and QDRO: Dividing Retirement Assets

When talk turns to the graying of America it is common to hear terms like Baby Boomers and the Sandwich Generation. Now we can add “gray divorce.” What is a gray divorce you might ask? It is the increase in divorces among couples age 50 or older.

Along with the emotional aspects of ending a relationship that may have lasted two or more decades, there is also the financial aspect. 

The National Center for Family & Marriage Research at Bowling Green State University in Ohio did a study and found that since 1990 the divorce rate for Americans over the age of 50 has doubled, and more than doubled for those over the age of 65. Fully 1 in 4 people experiencing divorce in the United States is age 50 or older and nearly 1 in 10 is age 65 or older.

There are many reasons for this increase in gray divorces, such as longevity and more financial independence for women. It has also been suggested that divorce at older ages is more likely to be between people who are in their second or third marriage. But the Bowling Green study found that half of all gray divorces are to couples in their first marriage and 55% of gray divorces are between couples who have been married for more than 20 years.

If a couple has been saving money for retirement, it is an asset of the marriage that must be addressed in the divorce settlement. This retirement plan could represent a large portion of the couple’s net worth. If the divorce settlement states that the proceeds of a pension and/or 401(k) plan must be split, a court must issue a Qualified Domestic Relations Order.

A Qualified Domestic Relations Order,  or QDRO, is a court-issued judgment, order, or decree that formally approves a property-settlement agreement that involves a retirement plan. A QDRO generally describes how the retirement plan assets will be divided between the retirement plan’s participant and his/her alternate payees. A QDRO is required for any retirement plan covered by the Employee Retirement Income Security Act (ERISA). Note that a QDRO is not necessary to divide an Individual Retirement Account (IRA) or a Simplified Employee Pension (SEP). In addition, military pensions, federal, state, county and city retirement plans have their own rules regarding division during divorce.

The only people who can be recognized as an alternate payee would be the spouse, a former spouse, a child, or other dependent of the qualified plan participant.  A spouse or other alternate payee under a qualified domestic relations order is treated as a participant for most purposes or rules relating to the taxation of distributions from qualified plans and, to the extent still available to participants, any special treatment of lump sum distributions. A QDRO will instruct the qualified plan administrator on how to pay the non-employee spouse’s share of the plan benefits. A QDRO allows those funds in a retirement account to be separated and withdrawn without penalty and deposited into the non-employee spouse’s retirement account. A series of distributions from an employee spouse’s qualified plan to the non-employee spouse would be exempt from the 10% early distribution penalty tax if the non-employee spouse is under age 59 ½. A lump sum distribution could be rolled over to an IRA for the non-employee divorcing spouse but distributions from that IRA prior to age 59 ½ would be subject to the 10% early distribution penalty tax. A QDRO distribution that is paid to a child or other dependent is taxed to the plan participant.

Unfortunately it is a common mistake to assume that the divorce settlement agreement will protect the non-employee spouses’ right to a portion of the employee-spouse’s retirement account. Generally that is not the case and that is why a QDRO is so important to insure the non-employee spouse gets their equal share of the retirement account.

The QDRO must be designed with language that is allowed in the retirement plan. That is why the QDRO should be drafted before the divorce is finalized. Many pension plans do not pay a lump sum amount. They will only pay a non-employee spouse on a monthly basis for lifetime starting at a specified retirement age. If the QDRO was drafted with language that requested an immediate lump sum payment of the amount due the non-employee spouse, it would be rejected by the retirement plan. If the non-employee spouse was relying on that money to live, that would be a terrible blow. If the divorce has been finalized, the non-employee spouse cannot go back to the court and request some other property that would have an equivalent value to that anticipated lump sum payment. Now the non-employee spouse may have to wait years to start collecting their portion of the monthly pension payments.

But if the QDRO was completed and presented to the retirement plan before the divorce became final, the non-employee spouse could negotiate a different settlement.

What if the employee spouse died between the time the divorce was finalized and the approval of the QDRO by the pension plan? After the divorce, the employee-spouse would be considered single and the monthly pension payments would be calculated on a single life basis. Upon the death of that employee spouse, any payment obligations of the pension fund would disappear. The non-employee spouse would not be entitled to any money. Another very important reason to present the QDRO to the retirement plan before the divorce is finalized.

QDROs can be complicated which is why it is important to have someone who specializes in QDROs draft the settlement. Divorce is a stressful time. Worrying about finances may take a backseat to the emotional fallout. Thinking about the future may be difficult but it is important that you do not walk away from the marriage without receiving your financial share.

Sadly for better, for worse, for richer, for poorer also applies in divorce. Be sure to speak with a legal professional to make sure you get your financial share.