Divorce proceedings inspire an assortment of financial challenges. Spouses typically need to negotiate terms for the division of both their marital assets and their shared debts. That process can be a complicated and lengthy one, especially in marriages where spouses have enjoyed a higher overall standard of living. They have more resources to defend and more reason to worry about a drop in their standard of living after the divorce.
Retirement accounts are often at least partially marital property. Spouses may have to share what they have set aside for retirement with one another. Any contributions made during the marriage are likely subject to division. People may worry about the financial implications of an early withdrawal from an account.
Penalties for early withdrawals are costly
There are two main financial concerns when people pull money out of a retirement savings account before they reach retirement age. Oftentimes, those accounts allow people to defer their income tax obligations. They make pre-tax contributions to the account and then pay income taxes on the amounts they withdraw as they use the account later in life. Early withdrawals could therefore significantly increase someone’s taxable income for the year and might even push them into a higher tax bracket.
Additionally, a penalty is likely if people pull funds out of a 401(k), Roth IRA or similar account before they reach retirement age. The standard penalty for early withdrawals can be as much as 10% of the amount withdrawn prematurely. Thankfully, spouses who divide their accounts using a specific process can avoid taxes and penalties.
Special documents sidestep financial penalties
The need to divide retirement accounts in a divorce is relatively common, so there are rules that allow spouses to do so without worrying about taxes and penalties. After the courts approve a property division order, one of the lawyers involved in the case can draft a qualified domestic relations order (QDRO).
Provided that both spouses cooperate and the document accurately reflects the property division order, it is possible to split the account without immediately triggering penalties and taxes. Spouses may have to share what they saved for retirement with one another, but they can at least preserve as much of that balance as possible by avoiding taxes and penalties.
Using the right tools for property division issues can make a major difference for those preparing for a high-asset divorce. A QDRO is a useful component of a high-asset divorce featuring retirement accounts.
