Community property rules mean that spouses generally have to split almost everything they acquire during marriage. Unless they reach a settlement on their own, a judge applies the community property statute after reviewing an inventory of marital assets and debts.
People sometimes assume that they can protect specific resources as their separate property, only to later learn that they are actually part of the marital estate. For example, 401(k) retirement accounts usually have a direct association with one spouse’s employment. They make contributions with each paycheck and may even receive matching amounts from their employers as a job benefit.
Despite ostensibly belonging to one spouse on paper, 401(k)s are usually marital property that are subject to division under community property statutes. If the couple has not yet reached retirement age, the account holder may worry about losing some of their savings to taxes and penalties.
Are such losses inevitable during a divorce?
There are ways to avoid tax consequences and penalties
Technically, any withdrawal from a tax-deferred retirement account could lead to tax consequences. People usually have to report the withdrawal as income. Especially when making a large change, such as removing half of the account balance, the withdrawal of funds before reaching retirement age might result in a much higher income tax obligation for the year.
There can be a penalty that applies as well. The rules for 401(k)s try to prevent people from taking money out of the account before they retire. Any sizeable withdrawal typically results in a 10% penalty based on the amount withdrawn.
Those penalties and tax consequences are not inevitable. In fact, there’s a relatively simple way to avoid them during a divorce. People simply need to have a lawyer draft a qualified domestic relations order (QDRO).
The use of a QDRO allows the professional managing the account to divide it into two separate accounts, each of which receives a specific percentage of the original account value. Provided that both spouses leave the funds in their individual accounts, neither spouse has to worry about taxes or a financial penalty.
While the thought of dividing retirement savings may make people anxious, it is possible to split a 401(k) without incurring further losses due to financial consequences. Learning more about the basic rules for property division in a divorce can help people achieve their goals as they prepare to rebuild their lives afterward.