A Qualified Domestic Relations Order (QDRO) is a specific type of order that directs a financial institution that services a certain type of retirement account or plan to distribute a portion of the account to another person. This is most commonly seen when a plan participant is in the divorce process and the plan participant is required by mutual agreement or by court order to distribute a portion of the retirement account to the other spouse or parent. The other spouse or parent (generally referred to as the “alternate payee” in legal documents) is receiving this portion to effectuate the division of the marital estate but it can also be incident to the other spouse or parent (or “alternate payee”) receiving a portion of retirement funds to account for any alimony or child support obligation of the plan participant.
The type of retirement account or plan that would require a Qualified Domestic Relations Order depends on if it meets the federal guidelines defined in the Employee Retirement Income Security Act of 1974 (ERISA). Most private employers who offer retirement plans implement retirement accounts and plans that fall under ERISA. The most common retirement accounts/plans that fall under ERISA regulations include the 401(k) and 403(b). Note: not all retirement accounts provided by all employers fall under ERISA regulations and therefore are not considered “qualified.” Common examples of non-qualified accounts include individually held IRAs or retirement benefits provided through government agencies.
When a retirement account is divided or distributed through the QDRO process, the transfer is tax-free from the plan participant to the alternate payee as the general process is just taking one retirement account and dividing it into two retirement accounts. However, if the alternate payee decides to take a portion of the distribution in cash or other form of distribution instead of reinvesting their distributed portion into a retirement account, then the alternate payee could be liable for taxes (similar to if the plan participant had chosen to take out retirement funds out early).
Prior to a QDRO, the parties need an underlying court order or agreement that determines how much the alternate payee is going to receive from the qualified retirement account. This amount could be a specific amount or a percentage. Generally, the parties also want to determine if the alternate payee is also going to receive passive gains or losses on the amount, as the QDRO process could take months to process. Since retirement funds are generally invested, the retirement investments could grow or decrease in value due to the investment options.
It is important for someone (alternate payee) who may be entitled to retirement funds from a qualified retirement account (such as a 401(k) or 403(b)) to consult with a family law attorney experienced in the QDRO process to ensure they get the legal documents needed for this distribution, especially due to the tax considerations involved.
A Certified Divorce Financial Analyst (CDFA) should get involved before a court order or agreement is put in place that distributes funds from a qualified retirement account or plan, as the CDFA can analyze different financial scenarios incident to divorce. Such financial scenarios can help a party and their attorney determine the structure and options in settlement negotiations, and all parties and attorneys involved can get a bit more creative. For example: a CDFA could layout the pros and cons in receiving more money from a retirement account in comparison to selling the former marital residence and distributing the net proceeds (and the implications for either or both parties should they purchase new houses and the ripple effect implications of that (especially with increased interest rates on new real property purchases as compared to a few years ago)). Although a Judge has less options on getting creative, the CDFA can still assist in trial preparations to assist a party and their attorney by laying out the financial implications of what is commonly ordered in the Courts.
A Financial Planner or an Advisor generally gets involved right after the distribution of the retirement account funds (in addition to any other distributions to account for the entirety of the marital estate and/or money transfers incident to alimony and child support payments), as the Financial Planner or Advisor can assist the person in figuring out what to do with said money and investments. The Financial Planner or Advisor can also assist the person in protecting themselves moving forward and planning for the future as a single person or single parent.
If you or somebody you know wants to learn more about QDRO’s, our team at Modern Legal is here to help.
Please note: these educational materials are based on North Carolina law where my legal practice is based. While the insights may have wide applicability, readers should consult with an attorney regarding the specific laws in their state or country.
