Navigating financial matters is often one of the most complicated elements of divorce. Divorcing spouses frequently disagree about how to share their resources and divide responsibility for their shared obligations, such as their credit card balances.
Community property rules leave almost everything acquired during marriage vulnerable to division when people divorce. In some cases, spouses may suffer secondary financial consequences. For example, selling a house usually requires the support of a real estate agent. Paying for an agent consumes a certain percentage of the total sale cost.
Those who have to divide their retirement savings may also need to consider the possibility of secondary expenses when preparing for asset division.
Early withdrawals can trigger penalties
Some types of retirement savings accounts are technically accessible at any time. For example, if the spouses funded a Roth IRA during the marriage, the decision to withdraw funds from that account simply results in a reduction of the available balance.
However, there are penalties to consider when dividing certain types of retirement savings accounts. People who have funded 401(k)s and similar tax-deferred retirement accounts are at risk of a penalty. The standard penalty for a retirement withdrawal is 10% of the amount taken from the account.
In a scenario where the spouses agree on a 50/50 split, they could lose 10% of the amount withdrawn to compensate the other spouse. The spouses also have to report those funds as income, which can result in income tax consequences.
Thankfully, there is a simple way to sidestep those frustrating consequences. After the courts approve a final property division order, the spouses can have one of their lawyers draft a qualified domestic relations order (QDRO). A QDRO allows for the division of the funds in the account without generating tax consequences or financial penalties.
The professional managing the account can use the QDRO to start a new account in the name of the other’s spouse. They can move a specific percentage of the account balance into that new account without the spouses risking taxes and penalties.
Those who have retirement resources included among their marital assets may need to approach property division carefully to limit the possibility of secondary financial losses. Having the right support while preparing for divorce may make it easier for people to handle complex financial matters with minimal long-term losses.