How Retirement Plans Are Divided in Divorce

A businessman puts his hands between two stacks of coins as if keeping them separate.

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published 26 September 2024

Editor’s note: This is part eight of an ongoing series throughout this year focused on helping older adults navigate the financial difficulties of gray divorce. See below for links to the other articles in the series.

Chances are you've never heard of a QDRO. Which may be a good thing, as it means you likely haven't gone through divorce, or you don't work in the divorce field. But if you're an older American with a decent-sized 401(k) or pension, and you find yourself part of the phenomenon known as gray divorce, the QDRO will likely play an extremely important part of your divorce settlement and your financial future.

It’s critically important you and your attorney make sure your QDRO is properly prepared to avoid costly financial mistakes.

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So, what is a QDRO? It's an acronym for qualified domestic relations order, which is used in a divorce proceeding to instruct a retirement plan to pay a spouse or a former spouse his or her community property rights in the retirement plan. QDROs are simple documents, but they can be tricky to prepare. And for that reason, it's important to use a professional with QDRO experience.

“Retirement plans come in all shapes and sizes,” notes family law attorney Shann Winesett. Winesett operates Las Vegas QDRO, a firm that assists litigants and attorneys across the country in dividing retirement assets in divorce, which can be large in a gray divorce. “Knowing what type of plan you are dealing with is essential to the proper division of retirement benefits.”

There are two main types of retirement plans divided by QDROs:

Defined contribution plans (DC plans). Examples of these are 401(k)s and 403(b)s.
Defined benefit plans (DB plans). These are commonly referred to as pension plans.

Many attorneys make the mistake of using the same language to divide the different types of plans. For instance, pension plans are divided by a coverture fraction, also known as the “time rule.” The number of years the spouse was married while participating in the plan is divided by the total number of years the spouse has been in the plan. The resulting fraction is multiplied by the pension benefit to determine the spouse’s portion (see an example in action). “Never use the ‘time rule’ to divide a defined contribution plan,” notes Winesett, who educates attorneys on common errors with QDROs. “It can create an unintentional windfall for one of the parties.”

Other common QDRO errors

Attempting to divide non-divisible plans. The “qualified” in QDRO refers to whether the plan is governed under a federal law known as ERISA (the Employee Retirement Income Security Act). Note that IRAs are not considered qualified plans and do not require a QDRO.

An important side note regarding IRA rollovers from 401(k)s in divorce: Distributions from an IRA prior to age 59½ are usually considered an early distribution and subject to a 10% penalty in addition to ordinary income tax. A transfer of the qualified retirement plan like a 401(k) (or a portion of it) to a spouse as part of a divorce settlement pursuant to a QDRO is exempt from this rule. So, if you're receiving a portion of your spouse’s 401(k) and need to take a distribution, do it before you roll it into your IRA to avoid the 10% penalty. Ordinary income taxes still apply.

Failure to address loans when dividing a defined contribution plan. Most DC plans consider a loan as an asset of the account, not a debt. If a participant has taken a loan against the plan, you and your attorney should know how that loan will be treated in the account’s division. Ignoring this could result in receiving less than intended.

Failure to address gains and losses when dividing DC plans. The longer the period between the entry of the decree and the division of the retirement funds, the greater the likelihood of gains or losses in the retirement account. The divorce settlement must address what happens to earnings and losses awarded to a spouse between the date of division and actual payment.

Failure to address survivor benefits in pensions. Surviving spouse benefits can be complex in defined benefit pension plans. It's important to determine if the participant already made an election that's irrevocable. Did they make an election for a survivor annuity?

Is there an option for a separate interest QDRO? A separate interest splits the plan balance between the participant and the alternate payee before payments have begun. It allows the non-participant spouse to have their own pension benefit completely independent from the participant.

Logistical issues

There are also logistical issues, such as failing to stipulate who's responsible for drafting the QDRO and even failing to implement the QDRO. Believe it or not, attorneys often fail to agree on which party is responsible for drafting the QDRO or fail to set a timeline for when the QDRO must be pre-approved by the plan administrator.

Winesett notes, “In many cases, the retirement plan is the most significant asset in the marriage. It's surprising how indifferent the family courts and many family law practitioners seem to be when it comes to dividing this valuable marital property.”

Don’t forget. Once the divorce is finalized, the QDRO needs to be implemented. In my financial advisory practice specializing with late-life divorcees, I've seen one spouse wait six years before executing her rights through the QDRO to half of her ex-husband's 401(k), suffering a loss of investment gains. Such cases show that despite the relief you might feel after divorce, there's still work to be done. Much of my practice involves helping people with the work of getting new retirement accounts set up after divorce.