Going through a divorce is one of those unplanned events that can impact your retirement savings.

One of the most common financial questions when going through a divorce is, "what happens to my retirement plan"? It's important for you and your spouse to understand how to protect your retirement plan from distributions and unnecessary taxes.

The funds in a 403(b) or 457 plan accumulated during a marriage are considered the marital property of both the husband and wife. Generally, laws do not require that the retirement plan itself be divided, as long as the spouses get equitable assets. For example, a settlement may state that the plan participant retains the assets of a 403(b) or 457 plan’s assets, and the other spouse is awarded other assets, such as the house.

Qualified Domestic Relations Order (QDRO)

For the division of your plan or your spouse’s plan to be included in the settlement, one of the parties needs to request it as part of the divorce proceedings. A separate court order, called a qualified domestic relations order (QDRO), must be obtained.

The QDRO ensures that the plan sponsor recognizes a non-employee spouse’s right to a portion of the plan after divorce. Once the court issues the QDRO, naming the non-employee spouse as alternate payee, a copy must be sent immediately to the plan administrator.

Information to know

  • The amount of the QDRO proceeds and when they should be paid.
  • The QDRO must not conflict with any of the plan’s restrictions regarding payout options and timing of the payout.
  • If there are conflicts with the QDRO, the plan sponsor can declare that it is unenforceable and you’ll need to go back to court to get the order revised.

Once the divorce is final, the QDRO allows the plan to transfer the portion of funds allowed by the court into an individual retirement account (IRA) for the non-employee spouse. By doing so, the money retains the tax-deferral benefit. The funds are also excluded from the additional 10% penalty that would normally be incurred with an early withdrawal from a qualified retirement plan.

With the QDRO, a portion of the plan payment could also go directly to the non-employee spouse rather than into an IRA. This may be necessary to pay expenses, such as attorney fees. However, be aware that, although there will be no 10% tax penalty, any portion of money not transferred immediately into an IRA becomes taxable for that year.

Before heading to court:

  • Determine the value of your assets
  • Check with your district for details about your plan’s payout options
  • Consider your 403(b) or 457 plan’s potential for future growth vs. that of your other property
  • Consider any associated taxes and fees
  • Consult a tax attorney so you know your financial rights and obligations