7 Common Mistakes When Using a QDRO to Make A Distribution

When couples divorce, a qualified retirement plan (such as a 401k) might be the largest asset for the spouses to divide. This is especially true when there isn’t a house at stake.  

Each employee should be familiar with the rules. At the very least, the employee can talk with their retirement plan sponsor.

However, this can be a big challenge for the non-employee spouse.  In most cases, the spouse has little knowledge of the qualified plan details, because that’s what the employee spouse took care of. 

Because a divorce usually has so many competing priorities, it’s easy to make mistakes when it comes to dividing assets. When it comes to dividing a retirement plan, the biggest challenge is ensuring that the QDRO is written properly.

How a QDRO Works

QDRO stands for qualified domestic relations order. A QDRO is used to divide qualified retirement plan assets in a divorce.

Usually, a divorce attorney representing one of the spouses writes the QDRO in a divorce case. Handled correctly, a QDRO ensures each spouse has a fair, tax-efficient allocation of the retirement plan assets. With a little diligence, it is possible for both spouses to keep their fair share without Uncle Sam taking a cut. 

Handled incorrectly, and both spouses can lose. There are many mistakes that spouses can make when dividing retirement assets. And some of those mistakes can lead to paying unnecessary additional tax or a tax penalty.

With that in mind, here are 7 common QDRO mistakes that you might make when transferring your ex-spouse’s 401k into your own account, and how to avoid them. 

QDRO mistakes can significantly impact the non-employee spouse
Avoid these mistakes with your QDRO

Video walkthrough

Mistake #1: Assuming the QDRO tells the plan administrator what to do. 

Before dividing the employer-sponsored retirement plan assets, the retirement plan administrator will require a QDRO. A QDRO gives specific information to the plan administrator.

This information is helps the administrator properly divide the assets between the two spouses. But there are 4 things about a QDRO that you should know.   

4 Things You Should Know About A QDRO 

  1. No qualified plan can divide retirement benefits without a QDRO. This applies to any plan covered by the Employee Retirement Income Security Act (ERISA) of 1974.  
  2. The judge does not draft the QDRO as part of the divorce settlement. The divorce attorneys should draft the QDRO. If they cannot do this, then you might need to hire a specialist to help draft the QDRO. Once both parties agree on the QDRO language, the judge should approve it.
  3. The QDRO is not automatically included with divorce decree. This is a separate effort that you need to discuss with your attorney.   
  4. The QDRO cannot make the plan administrator do anything that the plan doesn’t already allow. This is probably the most important fact. Yet almost everyone overlooks this fact.

In fact, the plan administrator has the authority and responsibility to determine whether a domestic relations order is actually qualified in the first place. To do this, the plan administrator must follow the plan’s procedures.

In other words, if the court order tries to achieve something that’s not allowed in the plan, then the administrator can determine that the order is not ‘qualified.’  

This means the QDRO has to go back to the court to be rewritten in a manner that complies with the plan document.

How to avoid this QDRO mistake 

There are several things you can do to avoid this mistake.

Make the QDRO distribution a priority in finalizing the divorce.

As long as the marriage still exists, you have certain rights within the retirement plan.  

For example, federal law requires any ERISA plan to make the former spouse the default beneficiary. This is important down the road, in case there is a new surviving spouse.

However, once the divorce is final, all bets are off. It might not always be practical to have the final QDRO by the time you sign the divorce papers. However, you should at least be far along enough to see the finish line.  

Hold your lawyer accountable for drafting the QDRO. 

No one is responsible for drafting a QDRO. So don’t assume that it just gets done as part of the divorce process.  

Furthermore, most attorneys will agree that it is the non-employee spouse’s responsibility to:

  • Ensure the judge signs the QDRO, AND
  • Ensure the 401k administrator accepts the QDRO.

After all, it’s in the ex-spouse’s interest to avoid QDRO distribution mistakes.

Have the plan administrator review a draft QDRO before it goes for signature. 

Be aware. Not all plan administrators will do this.  

However, if your spouse’s plan does allow for a QDRO review, you should have your lawyer send a draft copy of the QDRO to the administrator.  That way, you can make any necessary adjustments before the judge signs off. 

Done correctly, this should help to minimize unnecessary re-writes and legal fees. 

Familiarize yourself with all the employee benefits.  

It’s important to understand what you might be entitled to under the plan itself. But you should take the time to review ALL available employee benefits. 

You might find other available plans or benefits that you could be otherwise entitled to, such as a health savings account, employee stock, or a non-qualified plan, such as deferred compensation.   

Mistake #2: Taking a taxable distribution when you don’t have to 

When it comes to moving money from a qualified retirement plan, that’s called a distribution.  

QDRO distributions from a pre-tax retirement plan are subject to federal income tax unless they qualify as an eligible rollover into a new retirement plan.  

You can do this in one of two ways.

Direct rollover

A direct rollover is a request to the plan administrator to directly transfer the funds into another retirement account. Some plan administrators will establish a separate account within the plan, if that is what the QDRO directs.

Or the administrator can directly transfer the assets into a retirement plan that you’ve set up separately. This might be called a trustee to trustee transfer.

Many people set up an IRA for this purpose.  

60-day rollover

If you don’t arrange for a direct rollover from the plan administrator, you will likely receive a check for the specified amount, minus income taxes. The IRS requires that all retirement plan distributions be subject to a 20% withholding, even if you intend to roll it over later. However, this does not apply to direct rollovers or trustee-to-trustee transfers.

Generally speaking, you have 60 days from the date you receive a QDRO distribution to deposit the money over into another plan or IRA. After 60 days, that money is considered to be taxable income, and subject to federal income taxes (and possibly an early withdrawal penalty).

For people who are able to complete a direct rollover, there isn’t usually an issue. However, if you receive a check, and your intention is to put this money into your own IRA, be careful.

Why you might violate the 60-day rollover rule

There might a couple of reasons you inadvertently might run afoul of the 60-day rollover rule: 

Reason #1: You don’t have a QDRO on file, but you decide to pull the money out anyway. 

Under Internal Revenue Code §72(t)(2)(c), one of the exceptions to the early withdrawal penalty is if the money is paid to ‘an alternate payee under a QDRO.’  

However, due to cash needs, you might be tempted to have your soon-to-be ex-spouse pull the money out, then send you the proceeds.  

In most cases, this probably will end up in a result that neither of you want. Yet another reason to make sure your QDRO gets done properly.   

Reason #2: You don’t replace the taxes withheld. 

When issuing a QDRO distribution to a non-retirement account, ERISA plan administrators are required to withhold 20% of the distribution and remit them to the IRS for tax purposes.  

This is true in all cases, even if you intend to put the money back into a retirement account in the future.  

The primary exception to this is when the plan administrator sends a distribution check to you, but it’s made out to the IRA or other retirement plan account. However, if taxes are withheld, you have to fund the new account with the entire gross distribution. This includes the withheld taxes.  

Otherwise, the QDRO distribution does not comply with the 60-day rollover rule.   

Example

For example, let’s imagine that you receive $50,000 from your ex-husband’s 401(k) in the form of a check made out to you.

You should expect that check to be $40,000 ($50,000 minus 20%).  Let’s say you plan to roll this over into a new IRA you set up.  In order to qualify as a non-taxable event, you would need to deposit the $40,000 into your IRA, plus $10,000 to make up for the taxes that were withheld.   Otherwise, it doesn’t count as a rollover.   

Note:  If you complete the rollover, you will eventually get the $10,000 back when you file your tax return, but that doesn’t help you now.   

You don’t have your IRA set up, so you have no place to deposit the check.  

It should go without saying that if your intention is to have the plan administrator send funds directly to your IRA, then you need to have an IRA already established in the first place! 

How to avoid this QDRO mistake 

There are several ways to avoid inadvertently triggering a tax bill.

Spell out exactly what you want in the QDRO. 

The QDRO should tell the plan administrator: 

  • How much money you want to transfer to another retirement account.
  • Which account that money will be transferred to.  This can be an account:
    • Already set up for you as the alternate payee, OR
    • Another retirement plan you’ve already established.
  • How much money you want directly disbursed to you (if any).

This last step allows you to avoid early withdrawal penalties.

You will still be subject to ordinary income tax on distributions from pre-tax (or tax-deferred) accounts. This early withdrawal rule might not apply if you’re age 59½ or older. 

Arrange for a direct transfer or rollover. 

If possible, avoid having the money sent to you directly.  

As long as the money is kept out of your hands, the plan administrator does not have to withhold taxes. The plan administrator also does not have to report it as a taxable event to the IRS. 

If the plan administrator insists on sending you a check, check with your financial institution to make sure you understand how the check should be made out.  

Usually, the check will be made payable to your new account. However, you can avoid hassles by verifying the exact verbiage that should be on the check. 

Open your own retirement account, if you don’t already have one. 

Even if it’s not funded, having your own IRA will help you avoid this pretty simple mistake. 

Mistake #3: Paying an unnecessary tax penalty

As previously discussed, under IRC §72(t)(2)(c), one of the exceptions to the early withdrawal penalty is if the money is paid to ‘an alternate payee under a QDRO.’  

Let’s imagine that you need some money to pay for living expenses or for a major purchase (like a car or down payment on a house). And you might intend to use some of your divorce money as a source of that cash. In that case, you might want to take a hard look at ALL of the available options.

But there might not be any other options. This might be your only choice.  That’s okay.  

But while you should expect to pay taxes, you should NEVER pay a penalty. This is true even if you’re under the age of 59 ½.  

How to avoid this QDRO mistake

Talk with a Certified Divorce Financial Analyst™ (CDFA) about your finances before finalizing your QDRO.  

A CDFA™ has specific training to help people with their financial planning needs during, and after a divorce.  A CDFA™ can help you create a post-divorce financial plan.

This plan should help you ensure that you’re only taking out what is necessary, even if things change. 

Be very clear in your QDRO about how much money is coming to you, and how much is going to a retirement account.  

In fact, since account balances can fluctuate, you should specify the exact dollar amount that goes directly to you, with the remainder going to the retirement plan (if the plan allows). 

Do not take more money that what is specified in the QDRO.  

Even if plans change.  

Mistake #4: Overlooking employer contributions 

When most people consider a defined contribution plan, they think about employee contributions. However, they might be overlooking employer contributions.

Depending on the plan, and how long your ex-spouse has been a plan participant, this could be a huge chunk of money. It’s important not to overlook the employer contributions when dividing up the plan.  

But first, a little background: 

Employee contributions to a defined contribution plan are always vested.  This means that when they leave the company, employees can take the money from their plan that they put into it.  

Regardless of why they’re leaving the company. It’s their money, so they can move it.   

Employer contributions are a little different.  Employer contributions are either vested or non-vested. Vested employer contributions are portable, just like employee contributions are.

Non-vested employer contributions are not portable. While the account balance usually reflects both vested & non-vested employer contributions, non-vested contributions usually disappear if the employee leaves the company. 

Why does this matter?

When you’re dividing retirement plan assets, you need to ensure that vested employer contributions are included.  

If your soon-to-be ex-spouse is entitled to those assets, then you’re entitled to your fair share in your QDRO distribution.

How to avoid this mistake

There are several important steps you can take to ensure that you receive everything you’re entitled to.

Ensure the financial affidavit and supporting documents include ALL employer contributions.  

If you’re not sure that they do, ask for the most recent statement. This should break down the account balance, as well as employee & employer contributions. 

Ensure that the equitable distribution worksheet includes ALL employee AND vested employer contributions.   

If there is a significant amount of non-vested contributions at stake, have a discussion with your lawyer. 

This is where things get sticky.  

Depending on which state you’re in, and what type of plan you’re discussing, this can go in many different ways. And there is no easy way to determine where this will go.

While many states recognize non-vested contributions, you’ll want to have an in depth discussion on how this might play out.  

Mistake #5: Not understanding the difference between different plans

In any divorce, one of the biggest tax mistakes you can make is assuming that all retirement plans are the same. Here are some common differences you need to account for.

Roth accounts vs. non-Roth accounts

Let’s look at a $100,000 traditional IRA to a $100,000 Roth IRA.

You should understand that qualified distributions from a traditional IRA will always be taxed. This is understandable because the contributions were tax-deductible (or pre-tax contributions).  

Conversely, qualified distributions from a Roth IRA are not taxed. This time, it’s is because the contributions were made with after-tax dollars. 

So let’s assume that you have a $100,000 traditional IRA and your soon-to-be ex-spouse has a $100,000 Roth IRA.  Since they are individual retirement accounts, it might be easier to just declare your account to be yours, and his account to be his.

However, let’s look at the after-tax value of these accounts (not including investment returns).  Let’s assume that you’re in the 22% tax bracket.

If you withdraw your account balance at a 22% tax rate, your traditional IRA would only yield $78,000.  Meanwhile, your former spouse would be able to pull $100,000 out of his Roth account tax-free. This assumes qualified distributions in both cases (and no tax penalties).

The tax treatment of a Roth IRA and a Roth 401(k) are the same. So the same principle applies to dividing 401(k) plans. Or when trying to divide multiple 401(k) plans AND IRAs.  

The best way to avoid this mistake is to ensure you know which accounts are Roth accounts (tax free qualified distributions), and traditional retirement accounts (taxable qualified distributions). 

Defined Benefit vs. Defined Contribution Plans

Defined benefit plans (pensions) aren’t as common as they used to be. But it’s important to understand your rights and available options. Here are some situations where you might want to have a financial expert help you:

  • Handling military retirement pay
  • Private retirement plans
  • Lump sum payment options
  • Navigating a state employe benefit plan

How to avoid this mistake

It’s easy to mistakenly believe that all retirement plan assets are the same. You’ll have a better chance for success if you do the following:

  • Proceed slowly so you can completely understand everything at stake.
  • Bring in an expert.
  • Ask questions.
    • Don’t assume things.
    • Make the experts explain things to you.

Mistake #6: Not accounting for company stock 

Many employer-sponsored retirement plans offer the opportunities for employees to purchase stock.  

If this is the case in your spouse’s situation, you should understand that there could be tax planning opportunities regarding the company stock within the plan.   

How to avoid this mistake

Detailing the intricacies of this tax treatment (known as net unrealized appreciation) is outside the scope of this article.  

However, you should consult with a financial professional, like an accountant or a Certified Divorce Financial Analyst (CDFA®) so you can better understand what your options are. 

Mistake #7: Exposing assets to creditors unnecessarily 

Be sure to account for differences in creditor protection when splitting a 401(k) or IRA plan.
Defined contribution plans provide more creditor protection than IRAs

If creditors might be coming after you, then you’ll need to plan accordingly.  

ERISA protects most employer plans, like 401(k) plans, from creditors.  This includes bankruptcy and non-bankruptcy situations.  

However, once those assets move from a 401(k) plan to a non-ERISA plan, like an IRA, the rules change.  In this case, those assets would be protected under federal law in a bankruptcy case (as long as the money originally came from an ERISA plan). However, in a non-bankruptcy case, state rules might apply instead. 

How to avoid this mistake

If either bankruptcy or creditor action appear to be on the horizon, you’ll want to get legal advice from your attorney, or a bankruptcy attorney licensed to practice in your state.  

Navigating divorce proceedings is a difficult and emotionally taxing process.  During that time, you and your ex-spouse might make well-intentioned decisions that end disastrously.  When dividing your retirement plans, it’s particularly important to pay attention to the details.   

Frequently asked questions

What happens if a QDRO is never filed?

Since a QDRO is a court order, not filing a QDRO means that the QDRO doesn’t exist. After the divorce, if there is no QDRO, then the former spouse may not be able to receive the retirement plan assets as intended.

Who pays the taxes on a QDRO distribution?

If the QDRO distribution goes to a former spouse, then the former spouse pays taxes as if he/she were the plan participant. If the QDRO distribution goes to a child or other dependent, then the plan participant pays taxes on the distribution.

Who is responsible for drafting a QDRO?

Usually, the beneficiary spouse, or non-employee spouse, will be responsible for having the QDRO drafted. Although both parties can participate, the beneficiary spouse has every incentive to ensure that the QDRO properly reflects both parties’ intent.

Who pays for drafting a QDRO?

This can be negotiated between the two parties. A fair way to allocate the cost is to simply split the QDRO fees down the middle, 50/50.

What do you think?

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4 Comments

  1. Diane Bush says:

    In my divorce in which I had to represent myself (pro se), the Court ordered a QDRO. a set dollar amount for my ex-spouse to pay me for my portion of the marital home (from his portion of his 401K) in which he was responsible for paying 12% for tax liability and any penalties of that withdrawal. The second amount was for the division of the 401K. QDRO Consultants who finalized the QDRO stated this by referring to the section in the divorce decree. When the investment company (Voya) moved the money they did one transfer leaving me with the 20% penalty. I have fought with Voya and QDRO Consultants for over a month and was left having to disperse some to live on and roll the remaining into an IRA. Who do I contact to resolve this since I still do not have the money for an attorney? Thank you in advance for your assistance.

    1. Forrest Baumhover says:

      Diane,

      I’m sorry for your situation. It seems that the 20% withholding is not a penalty, but the mandatory withholding that occurs with all 401k withdrawals. I would recommend the following:

      1. Contact a pro bono legal aid office in your state. You should be able to find one through the bar association for your particular state. You should be able to have a lawyer help you understand whether or not the QDRO was executed as written.

      2. Contact the IRS. Either the Taxpayer Advocate Service or a Low-Income Tax Clinic should be able to help you understand the tax impacts of the QDRO execution, and what your options might look like, based on the actual transactions that occurred.

      https://www.taxpayeradvocate.irs.gov/
      https://www.irs.gov/advocate/low-income-taxpayer-clinics

  2. Spouse’s 401k was divided in the last qtr of 2023 via QDRO, so my share is still in the 401k but now in my name, I did not have to roll it into an IRA and would prefer not to due to CT income tax law that favors 401k distributions over IRA distributions. I would like to take a distribution of $10k to $20k now in 2024. I thought I could take one distribution not subject to the 10% penalty, but not sure if I should have instructed them to do that when they split the account up.

    1. Forrest Baumhover says:

      I’m not a lawyer, but generally, distributions that are not specifically included in a QDRO might be subject to an early withdrawal penalty. I’m not sure what your options are, but I’d look at discussing it with the lawyers that drafted the QDRO.