Gray divorce, or divorce later in life, comes with many hidden costs, from losing a spouse’s healthcare benefits to splitting retirement accounts, which can impact day-to-day living and future plans. Roughly one-third of divorcees lost 25% to 49% of their retirement savings due to division, fees, or early withdrawals, according to a recent study from Western & Southern Financial Group. Another 28% lost half to all of their savings.
A detailed Qualified Domestic Relations Order can help preserve retirement assets. But only if it is constructed and executed properly. Yet, 43% of divorced women said they didn’t use a QDRO, while 76% said they believed the QDRO was used incorrectly, according to the Western & Southern report.
What is a QDRO? Who needs one in a divorce? Financial experts and divorce attorneys shared everything you need to know about a QDRO to preserve your wealth after divorce.
What is a QDRO?
A QDRO is a document drafted by an attorney that outlines how certain retirement accounts will be divided after divorce. A QDRO covers qualified retirement plans such as 401(k)s, 403(b)s, 457(b)s and certain pensions.
“A QDRO allows retirement assets to be divided between spouses and directs the retirement plan administrator on how to split the account—without triggering the taxes and penalties that would normally apply to an early withdrawal,” explained investor and author Diana Richey, CFP.
“Anyone dividing a non-IRA defined contribution plan as part of their divorce needs one,” added Julia Rueschemeyer, divorce lawyer at Amherst Divorce.
Benefits to a QDRO
There are certain money-saving benefits to a QDRO over liquidating investments to split in a divorce.
“QDRO distributions are exempt from the 10% early-withdrawal penalty even for recipients under 59½,” said Hollis Hardiman, CDFA™, wealth manager and partner at Merit Financial Advisors, noting that it can be a useful liquidity option under financial pressure.
Cash distributions are subject to 20% federal withholding taxes, and the recipient will pay income tax on future withdrawals unless the funds are immediately rolled into an IRA.
“There is no tax on the transfer if it is going into an IRA account,” Hardiman said.
Significantly, a QDRO also protects the account owner from paying taxes, which is especially important during a divorce when cash may be tight and tax situations may change.
“The spouse paying the benefits incurs no tax liability since the funds are not deemed a distribution,” said Yonatan S. Levoritz, Esq. of the Levoritz Law Firm.
“A QDRO allows retirement assets to be divided between spouses and directs the retirement plan administrator on how to split the account — without triggering the taxes and penalties that would normally apply to an early withdrawal.”
When should you skip a QDRO?
A QDRO costs money for an attorney to draw up, and can take several months to execute, according to Hardiman. “If the client can offset the retirement distributions with IRA funds and still accomplish the division [they want], it might be best to skip a QDRO and divide funds,” she said.
Rueschemeyer emphasized that an IRA does not require a QDRO to split funds.
There are other circumstances where divorcing couples may not need a QDRO.
“If employer-based retirement assets are relatively small, or if there are significant assets outside of that employer-based retirement plan, or if each spouse has an employer-based retirement account of relatively equal value, then it can be easiest to just divvy up the employer-based retirement accounts without a QDRO,” Richey said. “Each spouse keeps his or her own retirement account. Or, the working spouse keeps his or her retirement account and the non-working spouse gets non-qualified cash. In many cases, that leads to a cleaner break and fewer administrative steps, while still achieving a fair economic outcome.”
When should you push for a QDRO?
Don’t let a financial planner or your spouse’s attorney try to convince you to forgo a QDRO if it would benefit you.
“Any spouse entitled to a share of the other’s workplace retirement plan should be asking for a QDRO and in gray divorce, that’s almost always the lower-earning or non-working spouse. These accounts are often the largest asset in the marriage, sometimes worth more than the house,” said Shawna Bieda, CFP, CDFA, senior wealth advisor at XML Financial Group.
Avoid these mistakes
Bieda also said that she often sees couples fighting to keep a house while ignoring the funds in a pension or 401(k). While it may be important to keep a home, especially if one party is still working and doesn’t want to move, if you’re viewing the house as an asset to sell, the retirement account could be worth more.
“I recently had a client who came to me after her divorce was already finalized,” Bieda said. “She’d kept the house, which felt like a win at the time. What she didn’t realize was that she’d walked away from a pension worth nearly twice what the house would net her after selling costs and taxes.”
Bieda said accepting a house instead of other assets is most common mistake she sees.
“Splitting accounts without looking at the after-tax value is another one,” she said. “Many don’t realize that a $500,000 IRA and a $500,000 brokerage account are not the same thing.”
Make sure the QDRO is equitable or in your favor
The earlier in the divorce process you start, the better it is if you’re pursuing a QDRO. Even though the QDRO isn’t presented until the end of the divorce case with other final documents, Levoritz said, “Start discussions about obtaining a piece of the retirement assets at the beginning of the case.”
Also, make sure you know what you’re asking for and the true value. “[Divorcees] are too quick to let assets that could appreciate go without a fight,” Levoritz said. “They don’t see to value and appraise every asset.”
That willingness to fight for what’s fair can mean the difference between a secure financial future or struggling after your divorce.
“In the eyes of the law, a divorce is just like any other adversarial legal proceeding,” Richey said. “It can be difficult to see your soon-to-be ex-spouse as the adversary. But, to protect your financial future, you have to be tough and negotiate.
Related: After a ‘gray divorce,’ protect your money
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