People in California who are getting a divorce might need to divide a 401(k), but it is essential to avoid mistakes that could be costly. To split a 401(k) or a pension plan, a document called a qualified domestic relations order is necessary.
The QDRO must reflect the parameters of the divorce agreement, but it must also be approved by the plan administrator. The distribution may be rolled into an IRA or a person may take the payout, but the QDRO must specify how it will be received. In the latter instance, the person will pay income tax on the distribution.
The spouse should not be changed as beneficiary on the 401(k) before the divorce is final because if the owner dies, the other spouse might not get access to it. The divorce decree and the QDRO should state the amount each person will get using percentages instead of actual amounts. This ensures that the split will remain fair if the value fluctuates after the time of the initial agreement. A person who is considering bankruptcy might want to leave money in the 401(k) since it is protected from creditors while an IRA is not. A QDRO is not necessary to divide an IRA, but it is still necessary to follow rules and take steps to avoid taxes and penalties.
Another option for couples who have a retirement account to divide might be for one person to take an asset that is roughly of equal value to a share of the retirement account. However, if this is done, it is important to make sure the amount is really equal. This means accounting for whether there will be taxes on withdrawal or if there are expenses associated with the asset. A person might also consider the liquidity of the assets.