Planning for retirement typically means spending years setting aside small amounts of money. You contribute a little from each paycheck to a special fund or account so that you can support yourself when you eventually stop working.
Many retirement savings programs like 401(k)s have tax incentives to motivate people to set money aside instead of spending it. The downside of such incentives is that there is a penalty for anyone who withdraws funds from these accounts before retirement age.
Most of the time, couples facing divorce will have to split the shared or marital portion of their retirement savings. Do those couples splitting up their retirement accounts in divorce have to pay taxes and penalties on any amount withdrawn early?
You can avoid penalties with proper paperwork
Once the courts decide the appropriate way to split up a shared retirement asset, the attorney for the person receiving some of the account’s balance will usually draw up a Qualified Domestic Relations Order (QDRO). This detailed document explains what amount to split off from the original account and whose name goes on to the new account established in the split.
Once the courts approve this document, the recipient or their attorney can file the paperwork with the retirement plan administrator, who can split the account according to the instructions in the QDRO. Unlike almost any other withdrawals from retirement accounts with tax incentives, a withdrawal due to a QDRO after a divorce will not incur any tax penalties.
Although you will still have to adjust to losing a portion of the account balance to your spouse, there will be no fees or penalties assessed by the government for early withdrawal, provided that the division occurs in compliance with the QDRO from the divorce.