California couples who are getting a divorce should be aware of potential tax liabilities in dividing retirement accounts. A qualified retirement plan, including a 401(k), a simplified employee pension plan or a profit-sharing plan, must be divided with a qualified domestic relations order. This is filed with the court and gives the other spouse the right to receive distributions from the account. It also makes the receiving spouse responsible for any income tax on payouts and allows the spouse to roll the payments into an IRA.
Without a QDRO, a person would be responsible for taxes on the distribution to the spouse. The money would be considered a taxable payout. Furthermore, there could be a penalty, and the distribution could also push a person into a higher income bracket for tax purposes. Therefore, it is critical to ensure that there is a QDRO and that it is prepared correctly.
A QDRO is not necessary for an IRA. However, it is important to wait to transfer the IRA to the other spouse’s IRA until the divorce papers specify this transfer. Prior to this point, the transfer would be treated like another retirement account transfer without a QDRO in which the person who owned the retirement account would be responsible for the same potential taxes and penalties.
Since California is a community property state, most marital assets are divided equally by the court although this is not always the case. A couple may reach a different agreement through divorce mediation, or a judge might make a decision in which the property is divided differently based on other factors. However, a person should be cautious about giving up a portion of the retirement account in exchange for the home or other assets because it can be important to long-term financial security.