Court order needed to split retirement accounts in divorce

Q: You wrote in a column that there is a one-time reprieve from early-withdrawal penalties if you cash out. I am recently divorced and my ex has his 401(k) account with about $3,000 that is mine. He tells me he can write a check, but I have to pay all the fees. How does this play into what you said about this one-time reprieve?

J.R.

A: Divorcing couples can split retirement accounts and even cash them out penalty-free as part of a settlement, but it has to be executed properly, and this is what many couples fail to do, divorce planners said.

Splitting up the 401(k) account should be done through a court-issued qualified domestic relations order, said Rita Medaglio-Barrera, a certified divorce financial analyst with Paragon Capital Management in Smithtown, N.Y.

"He can't just write her a check" and have it qualify for the penalty exemption, she said. "She's probably out of luck," because going back after your settlement and re-negotiating this is unlikely, she said.

Done properly, an ex-spouse can receive a one-time distribution from the plan without having to pay the early-withdrawal penalty of 10 percent. The income taxes due on the account still have to be paid, so that should be taken into consideration during the division of the couple's property.

If the spouse doesn't need the money right away, it can be rolled into an individual retirement account, though Medaglio-Barrera said individual employer plans often have their own rules governing how those rollovers are done, and it can involve a couple of separate administrative steps.

To be valid, the court-issued qualified domestic relations order must include (among other items) correct names and addresses of you and your soon-to-be ex, details on the division of the money and information on the retirement plan in question, the analyst said.

The professionals preparing the documents need to have the retirement plan's summary plan description, because that typically spells out the specific legal language needed in the order to be able to access the funds in the 401(k), Medaglio-Barrera said. Many plans actually contain language that must be repeated exactly in the order to be valid.

Then the retirement plan must verify the details of the order before issuing a distribution, a process that also involves several steps. In short, splitting up retirement plans shouldn't be an afterthought in a divorce. They require specific, detailed language of their own and must come directly from the employer plan, not your ex-spouse.

Finally, keep in mind that the orders cannot force an employer to perform actions that run counter to the company's summary plan description. Some plans allow couples to split the assets and then maintain two accounts in the employer plan. Others might require that funds remain in the plan until the employee retires. Many allow the immediate cash-out option, as well as the option to roll the money into an IRA, which is what most advisers recommend to help clients preserve some long-term finances as they exit a marriage.

From the Chicago Tribune.