Divorce Property Division - Using a QDRO

Summary:  Usually retirement plans are marital property and must be divided whenever there is a divorce.  However, such plans are unique because there is a restriction on withdrawals and adverse income tax effects. Federal ERISA and tax laws allow you to divide retirement plans in a divorce without having to pay income tax or the 10% early withdrawal penalty if you use the proper court order which is acceptable to the retirement plan.

General Rule for Dividing a Retirement Plan in a Colorado Divorce

Under Colorado (and all other states) law, a court must order the equitable (fair) division of marital assets in a divorce or legal separation. (Usually this means about a 50-50 split, but not always.)

The divorce division of most assets, such as the equity in a home, bank accounts, investments, and equity in vehicles, is done by assigning specific assets to each spouse and by transferring money or other liquid assets from one spouse to the other.   Assets can be swapped out and distributed "in kind" so that one spouse ends up with the home and the other keeps his or her 401(k).

They can "trade out" one kind of asset for another.

Retirement plan assets such as pension plans and 401(k) are marital assets which must be equitably divided or taken into account, just like any other marital asset.

Why Retirement Plan Assets are Different

However, retirement plan assets are very different from other marital assets.

Because the plan Participant (employee) is not free to liquidate or transfer part of a plan to any other person.  The only way that a plan Participant can transfer assets is to first take a taxable distribution to himself and them transfer the cash.  (However, most retirement plans prohibit any cash distribution to be taken prior to retirement or a minimum age.)

If such a transfer is made by taking a distribution, the plan Participant must pay a very stiff income tax bill, including in most cases an additional 10% penalty.

A transfer of a retirement plan asset cannot be done unless a special form of a court order is used. Such a court order allows the transfer of retirement plan assets to a former spouse, and it allows such a transfer to occur without the payment of any income taxes by the plan Participant (employee).

If the retirement plan is sponsored by a private employer (such as a utility company, a furniture store, a car dealership, etc.), then the special type of court order is called a Qualified Domestic Relations Order (QDRO).  This applies to most 401(k) and pension plans.

If the retirement plan is a government type plan, such as Colorado PERA, then other court orders such as Domestic Relations Order (DRO) or Court Order Acceptable for Processing (COAP) must be used. Although government plans are not divided through the use of a QDRO, the general procedure and effect are similar to the use of a QDRO.

So, in other words, a retirement plan cannot be divided as easily as other marital assets because of the restrictions on withdrawals and the tax problem.

Except that an IRA can usually be split pursuant to a divorce with a letter of instruction, without the use of a court order such as a QDRO.