Spouses contemplating divorce often delay the process due to financial concerns. They know they have to split their property, which diminishes their personal wealth. They also have to absorb the cost of the divorce.
Especially in scenarios where people are near the age of retirement and concerned about living on a fixed income, the financial implications of divorce may leave them feeling trapped. Most people know that they could face tax consequences and penalties if they have to withdraw funds from a retirement savings account before they reach retirement age.
Concerns about additional losses when splitting an account with a spouse could leave people unwilling to move forward with their wives. Thankfully, there is a document that can help people avoid taxes and penalties when splitting a retirement account during divorce.
Avoiding penalties and taxes is possible
Certain retirement savings accounts offer income tax incentives. People make pre-tax contributions to 401(k)s and similar accounts. They diminish their annual income, which reduces their income tax obligations. They then pay taxes on their retirement savings when they withdraw funds later in life.
Premature withdrawals from tax-deferred retirement savings accounts can push people into higher tax brackets, leaving them with income tax obligations. Additionally, there is a 10% penalty imposed for early withdrawals that further exacerbates the financial impact of dividing a retirement savings account.
Given how frequently spouses must address retirement savings during divorce proceedings, there is a procedure in place to help people limit their losses. Once there is a final property division decree, an attorney can draft a qualified domestic relations order (QDRO).
Each spouse must sign the document. The courts must review it to ensure it aligns with the property division order. After court approval, the spouses can then submit the QDRO to the financial professional managing the account.
The QDRO instructs the financial professional to move a percentage of the total account balance into a new account in the name of the other spouse. So long as neither spouse makes a large withdrawal after submitting the QDRO and splitting the funds, they can avoid the penalty and tax consequences completely.
Learning more about the unique tools that help people divide their property can be beneficial for those worried about their finances. It is possible to divide retirement savings without tax consequences and large penalties if spouses use the right paperwork.