Throughout my military career I’ve constantly been surrounded by acronyms.  The Army is notorious for them: APFT, MOPP, PMCS, AWOL.  These are just a handful of the thousands of them that exist.  Some I know.  Most I don’t.  I was constantly having to research what the heck most of them stood for.

While acronyms were expected in the military, I didn’t imagine how prevalent they would be in the financial services industry. One of the acronyms that I came across that I felt like I was in the military again was QDRO.  What makes it even more confusing is that I’ve heard it pronounced both “Quid-dro” and “Quad-dro”.  What’s the correct pronunciation?  The jury stills out on that one.

What is a QDRO?

And exactly what does it have to do with your 401K or pension plan?  A QDRO is a Qualified Domestic Relations Order from the court which indicates the beneficiaries of your retirement account, other than you.  These beneficiaries are also called “alternate payees” and this comes into play should you and your spouse get a divorce.

Usually, the beneficiaries of your retirement account(s) might be your spouse, child or other dependent, or a former spouse, and the QDRO will define how each of these people receive distributions from the retirement account through child support or alimony payments and/or property ownership.

It’s necessary that the information in the QDRO is followed exactly in order to minimize your potential to paying penalties on money you don’t even receive from your 401k plan.

The Importance of a Qualified Domestic Relations Order

If you should go through a divorce, the QDRO becomes extremely important.  Following the QDRO is the key to avoiding 10% early withdrawal penalties imposed by 401k plans, because if you don’t follow the QDRO you can be taxed on money taken from your 401k even if it landed in the hands of your beneficiaries!  Make sure to enlist professional help (either through your 401k plan administrator or a tax professional) to minimize your own tax implications of having to distribute your 401k to alternate payees due to divorce.

Take Steps to Verify Information in the Qualified Domestic Relations Order

If your 401k plan is subject to a QDRO during a divorce (typically if you have been married at least 5 years before getting divorced), you want to give the administrator of your 401k a copy of your QDRO.  This allows them to carry out the order.  They’ll review the QDRO to ensure it’s valid within 18 months and determine whether or not any payments must be made to beneficiaries. You’ll receive notification of any alternate payee (beneficiary) receiving funds from the 401k, and provided the QDRO was followed correctly, you will not have to pay a 10% early withdrawal fee from the withdrawal of the funds distributed to your beneficiaries.

The few QDRO’s that I’ve dealt with had been drafted directly by the attorney.  All I had to was open the appropriate account (in my cases they were IRA’s) and the money was transferred directly in. I like simplicity

Who Receives Money From Your 401k After Divorce?

Where you live will determine how your 401k funds are distributed after a divorce.  Most states have equitable distribution rules, which means your 401k is divided 50/50 between you and your ex-spouse – but it depends on how long you were married and how much was contributed, as well.

Some ex-spouses win 50% of a 401k plan even in states without equitable distribution rules, during the divorce proceedings. If you live in any of the following states, you can count on paying out half of your retirement to your ex-spouse:  Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin.  These are “common property” states.

For the QDRO cases I’ve worked in, all have been in the state of Illinois.  Although, not a “common property” state, each spouse did receive 50% of the retirement account balance.

What About QDRO’s and Pensions?

QDRO’s are most commonly associated to 401k’s, but while I was doing my research I learned that they can also apply to pensions.  According to the PBGC.gov website here are three items that QDRO’s must do:

1. Identity of the plan participant, each alternate payee, and each pension plan. A QDRO must specify the name and last known mailing address of the plan participant and each alternate payee covered by the order. A QDRO also must identify the name of each plan to which the order applies—this should be the plan’s formal name.
2. Amount to be paid and when payments start. A QDRO must state how much of the plan participant’s benefit is to be paid to the alternate payee, such as a dollar amount or percentage of the benefit, or make clear the manner in which the amount is to be determined. A QDRO also must specify or allow the alternate payee to choose when payments to the alternate payee will start.
3. What happens on the death of the plan participant and the alternate payee. A QDRO should specify whether the alternate payee will be treated as the participant’s spouse for purposes of any survivor benefits. A QDRO also should specify what happens to benefits when the alternate payee dies.

What a QDRO Must Not Require

There is sometimes a misconception on what a QDRO must and must not do.  The PBGC.gov site offers what a QDRO must not require the PBGC to do:

• pay any benefits not permitted under ERISA or the Code;
• provide any type or form of benefit, or any option, not otherwise provided by PBGC;
• pay benefits with a value in excess of the value of benefits that would otherwise be payable by PBGC;
• pay benefits to an alternate payee when those benefits are required to be paid to another alternate payee under an order previously determined to be a QDRO;
• pay benefits to the alternate payee for any period before PBGC receives the order;
• pay benefits as a separate interest to the alternate payee if the participant is already receiving benefit payments; or
• change the benefit form if the participant is already receiving benefit payments.

photo credit: ShellyS

John and Kate Divorced

Nobody gets married to then get divorced, but things change.  People change.  It’s an unfortunate reality of today’s generation.  Recent headlines of reality TV sensations John and Kate Plus 8 and their divorce filings is a sad reminder that it can happen to the best of us.  I’ve been fortunate as a financial planner to not have been involved in many ugly divorce cases, and for the few that I have been involved in, that’s more than my share than I want to have.  After the divorce is final is where the fun begins.

In an easy divorce, the assets are split down the middle, and for the most part, everybody walks away happy.  But in some cases, it gets much more complicated.  For example, let’s say that the ex gets the house and some of the stock holdings, and you’re left with the rest.  If the overall portfolios were allocated appropriately, the drastic market swings have probably left them completely out of whack.  For a financial planner like myself, there’s nothing more troubling than an out of whack portfolio.  In a common market, the impact might not be as severe, but it’s no news to anybody that we are not in a common market.  After the assets have been split, it’s important that the portfolios be realigned as soon as possible.  In addition to that, here’s a few more things that you want to consider.

Procrastination

Most post-divorce individuals do not get around the planning related issues for many months or even years, taking time to recover emotionally at first.  You need to realize how important it is to not postpone.  Most, with the help of their attorneys, will focus on the tax implications of the assets whenever they’re splitting things up.  In addition to the tax aspect, we also need to look at asset protection beneficiaries.  Divorcing clients often have substantial retirement accounts or other assets governed by beneficiary designations.

Remember your 401k at work?

Many times, you’ll forget about the beneficiaries you had on your 401(k) account, maybe annuities, or any other type of retirement account.  Once the divorce is final, you will want to make sure to double check and update these beneficiaries accordingly.  I’m not a big fan of keeping too much paperwork, but in this case you will want to keep a copy.  With my firm, we’ll always have a copy of the beneficiary designation form for your convenience, as well.

Be specific

When clients divorce, there’s a good chance there’s a critical area of making sure things are spelled out for each other correctly.   One aspect that is often over looked are the insurance policies.   With the divorce being imminent, the purpose of the insurance now may have changed.  Does it make sense to continue with the policies?  What about if there is built up cash value in the policy?  Divorce raises an issue whether one spouse maintains, after divorce, an “insurable interest” in the other spouse’s life or ability to continue earning an income at levels established or expected at the time of divorce.  Another aspect is if child support is not only required but all a necessity, then making sure that the paying spouse has enough life insurance to account if something were to happen to them.  As you can see, there are several details to be worked out.

College Savings

When kids are involved, that’s when it tends to get more interesting.  Most often than not, both parents will agree that saving for college is in the best interest for the kids usually in the form of a 529 plan.  One thing to consider though is that only one parent can be the owner of the account.  What’s the problem in that?   Well, if your ex-spouse is the owner on the account, they will always have access to cash out the funds at any time.  Divorcing couples should consider appointing an independent third party to be in control of the account.

Be Complete

Without an accurate picture of your marital income, expenses, assets and liabilities, you could get a poor settlement. Discovery is designed to uncover unaccounted for and hidden assets, unknown liabilities and missing information, but the best practice is to do your own homework as well.  Tax forms , financial documents,  and even safety deposit boxes will help you compile a complete and accurate balance sheet of your marital assets. Then, you can value the assets and liabilities, and identify which are marital and which are separate.

Don’t Forget Taxes

Your settlement could have severe consequences if you take an asset that will result in a big tax bill, while your spouse gets an asset with a small tax bill. The home is often the biggest asset in a divorce and usually has the most sentimental attachment. Buying out your spouse might seem like the best option, but be wary of possible tax implications of doing so.  Buying the home might lead you down a path of debt destruction.

In The End

When beginning divorce proceedings be sure to seek legal counsel.   Even in a “good” divorce when you think you can settle issues without attorney, you will be surprised on the little things that can arise such as property disputes, investments, and who will win custody of the children.   Little promises can be easily forgotten and it’s best to get it in writing.   Look for attorney that specializes in divorce to ensure that things are taken care of properly.

Securities offered through LPL Financial, Member FINRA/SIPC