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Avoiding mistakes with a 401(k) transfer

According to a 2016 American Academy of Matrimonial Lawyers survey, retirement accounts were among the assets fought over the most in a divorce. For those in Colorado and elsewhere who are splitting a 401(k) in a divorce, it is important to do so correctly. Otherwise, a taxable event may occur, which could reduce the value of the account. Transferring funds from a 401(k) in a divorce is done through a qualified domestic relations order (QDRO).

The order will spell out exactly how the transfer is to be made. Ideally, it will be crafted by an attorney who understands how to put a proper QDRO together. It should also be reviewed prior to being submitted to the court. If the money is put directly into an IRA, no taxable event occurs. If the money is taken as a distribution, no penalty is assessed regardless of the recipient's age.

However, the recipient would pay normal income tax on the proceeds. The tax rules are generally the same if funds are moved from an IRA into a rollover account. The only difference is if a direct distribution is made. In such a scenario, there is a 10 percent early withdrawal penalty for those under age 59½. Unlike a 401(k), there is no need for a QDRO for an IRA transfer.

Most assets obtained during a marriage may be eligible for division in a divorce. This generally includes funds contributed to a retirement account during a marriage. An attorney may be able to help an individual obtain a portion of a 401(k) or IRA in a final divorce settlement. Legal counsel may also be able to write the QDRO necessary to facilitate the transfer in a timely and correct manner.

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