Dividing property in divorce involves more than simply setting aside tangible physical assets to each spouse. Sometimes people confuse the ease of setting aside personal property – clothing, personal computers, books and the like – with assets a bit less tangible though still quantifiable, like investments. And dividing investment accounts requires understanding certain legal limits on divisibility and the potential tax consequences of a division.
Suppose one spouse has a 401(k) through work that currently has a balance of $100,000. The spouse worked at this company and contributed to the 401(k) both prior to and during the marriage. This means that part of the 401(k) is separate property (that earned before the marriage) and some is marital property (that earned during the marriage). Under Missouri law, the other spouse has an equitable share in the marital portion of this account.
But the investment account is not static and generally not meant for immediate withdrawal. In our example, let us say that the 401(k) has a marital portion of 80%, so that the other spouse has a 40% claim to the balance of the 401(k) at the time of divorce. How does the spouse get this marital share? Neither spouse would want the holder of the 401(k) to simply write a check for $40,000 – the withdrawal would have penalties associated with it and it would qualify as a capital gain taxable to one or both spouses, thereby depleting a large chunk of its worth. Also, if the fund is meant for retirement, taking the principal now will diminish the earning capacity of the investment in the future.
We need a way to transfer these funds without any penalties or tax consequences. And here is where we meet the QDRO.
A QDRO is a Qualified Domestic Relations Order, a creation of federal law. A QDRO allows a court to separate out a portion of a spouse’s retirement account and transfer its ownership to the other spouse. In our example, the parties would write up a QDRO that would award that spouse 40% of the value of the account as of the date of dissolution, and those funds would be transferred to an account in the name of that spouse alone. As long as the spouse does not immediately liquidate the account, the QDRO effects a transfer with no early withdrawal penalties and no capital gains taxes or income taxes.
A QDRO works for all types of investments, from a 401(k) to an IRA to mutual funds. In fact, without it, it may be almost impossible to divide very valuable marital assets.
If you have any questions about QDROs and divorce, contact us – we can help.