Retirement plans are often one of the significant assets up for distribution in the course of a divorce. Careful attention should be given to the type of retirement plan at issue to avoid tax penalties and/or early withdrawal penalties to the extent possible. First, retirement plans must be distinguished between qualified plans and non-qualified plans. Qualified plans include defined contribution plans such as 401Ks as well as defined benefit plans such as pensions. A Qualified Domestic Relations Order (QDRO) will be necessary to distribute a qualified plan. Non-qualified plans include individual retirement accounts or IRAs. A QDRO is not needed to distribute these plans.
Both qualified and non-qualified plans will be taxable as distributed. The QDRO effectuates a tax-free rollover of funds to the spouse being awarded a share of the retirement plan in divorce but the spouse will be taxed on it when they withdraw it. Distributions outside of a QDRO may also be subject to an early withdrawal fee. Typically, a 10% early withdrawal penalty applies to distributions before the plan participant is 59 ½ years old. There are a few ways to avoid the early withdrawal penalty including a loan from the retirement plan, disability of the plan participant, and scheduled equal payments. Additional exceptions for IRA plans include higher education expenses and for first-time home buyers.