If you’re in the middle of a divorce, you and your soon-to-be ex-spouse may want to determine how to handle any retirement accounts upon settlement of your financial matters. There is negotiation on who has a right to retirement accounts and who will be the named beneficiaries of the account. The way to finalize your agreement is having a court issue a qualified domestic relations order (QDRO).

What is a QDRO?

A “qualified domestic relations order” is a domestic relations order that creates or recognizes the existence of an individual’s right to receive or assign the benefits under a retirement plan.

The law calls a spouse receiving retirement plan assets an “alternate payee.” In addition to spouses and former spouses, the only other individuals who can be alternate payees under a domestic relations order are a child or other dependent of the retirement plan participant.

A domestic relations order is defined as:

  • A judgment, decree, or order (including the approval of a property settlement) that is made pursuant to state domestic relations law (including community property law).
  • Relating to the provision of child support, alimony payments, or marital property rights for the benefit of a spouse, former spouse, child, or other dependent of a participant.

A state authority, generally a court, must actually issue a judgment, order, or decree or otherwise formally approve a property settlement agreement before it can be a domestic relations order under a federal pension plan law called the Employee Retirement Income Security Act (ERISA).

Properly executed QDRO language is important for tax purposes. You don’t want to be hit with an unexpected tax bill because all the requirements were not followed (see right-hand box for more information).

Under law, there are certain provisions that a QDRO must not contain. It must not require a pension plan:

  • To provide an alternate payee (or participant) with any type or form of benefit, or any option, not otherwise provided under the plan.
  • To provide for increased benefits (determined on the basis of actuarial value).
  • To pay benefits to an alternate payee that are required to be paid to another alternate payee under another order, which was previously determined to be a QDRO.
  • To pay benefits to an alternate payee in the form of a qualified joint and survivor annuity for the lives of the alternate payee and his or her subsequent spouse

A QDRO may be included as part of a divorce decree or court-approved property settlement, or it can be issued as a separate order, without affecting its qualified status. The order must satisfy the requirements described above.

If an alternate payee is a minor or is legally incompetent, the order can require payment to someone with legal responsibility for the individual (such as a guardian or a party acting in loco parentis in the case of a child, or a trustee).

Although every QDRO must contain certain information, such as the names and addresses of the participant and alternate payee(s), the specific content of the rest of the QDRO depends on:

  • The type of retirement or pension plan (many have unique features);
  • The nature of the participant’s retirement benefits; and
  • The purposes behind issuing the order as well as the intent of the drafting parties.

QDROs are complex and vary widely because the terms set forth in them are unique to each factual situation. Consult with your attorney about how to use a QDRO in your current situation.

Tax Implications

A QDRO primarily establishes a spouse’s or ex-spouse’s legal right to receive a designated percentage of a retirement account balance or certain retirement benefit payments. Another benefit: A QDRO also ensures that your ex-spouse, and not you, will be responsible for the related income taxes when he or she takes retirement account withdrawals.

The QDRO arrangement also permits your ex-spouse to withdraw the designated share of the retirement account money and roll it over into his or her own IRA (assuming such a withdrawal is permitted by the terms of the qualified retirement plan in question). By a rollover, your ex-spouse can take over management of the designated share of the retirement account money while postponing income taxes until he or she begins taking withdrawals from the IRA.

A QDRO distribution that is paid to a child or other dependent is taxed to the plan participant.

So what happens without a QDRO? If money from your qualified retirement plan account gets into your ex-spouse’s hands without a QDRO in place, you face a disastrous tax outcome. Specifically, you’re treated as if you received a taxable distribution from the retirement account and then turned over the resulting cash to your ex-spouse. So you owe the taxes while your ex-spouse gets the money without owing any taxes. To add insult to injury, you could also get hit with the 10 percent early withdrawal penalty tax if the distribution occurs when you are younger than age 59 and 1/2.

As you can see, it’s critically important to get proper QDRO language into your divorce papers before signing off on yo