Dividing a 401(k) during divorce

Dividing a 401(k) during divorce

On Behalf of | Jun 7, 2023 | Divorce |

When a couple in Maryland divorces, they will likely need to determine how to divide their assets, including retirement accounts such as a 401(k). Deciding on a mutually agreeable solution can be challenging for both parties, as it carries emotional burdens. However, failing to reach an agreement could result in incurring avoidable tax expenses or losing a portion of their savings to the government. Fortunately, there are ways to streamline the process of dividing 401(k) funds.

Minimize tax liabilities

Understandably, tax liabilities may be one of the last things a couple thinks about as they go through a divorce. However, when dividing assets such as a 401(k), the primary focus should be on actively minimizing fees or tax liabilities that could erode the couple’s retirement savings. A crucial step in achieving this is proactively filing all necessary paperwork and meticulously detailing how all assets get divided.

Prearranged agreements

If the divorcing couple can come to an agreement where one spouse offers the other spouse marital assets of comparable value, perhaps a vehicle or a home, attempting to divide 401(k) funds could be avoided.

Qualified domestic relations order

When one spouse decides to relinquish a portion of their 401(k), they must complete a qualified domestic relations order. This document grants the other spouse the legal right to receive a specified portion of the funds into their 401(k). Usually, the 401(k) is divided into two separate accounts. Each spouse can independently manage their portion of the account, including making investment decisions. However, they will not be able to make direct contributions to the account.

Withdraw the funds

An additional option is withdrawing drawing funds from a 401(k) and using them to give a spouse their portion. This can bring heavy tax penalties if the individual withdrawing the funds is younger than 59.5 years. However, a divorce agreement could stipulate that the spouse who receives the funds is responsible for covering taxes and fees.

Dividing a 401(k) during a divorce is not always simple. However, by taking the time to understand what your 401(k) allows, you can make the process a little easier for everyone.