Additional QDRO Benefits: Taxes, Liquidity, and Bankruptcy, Creditor & Tax Lien Protection
TYPICAL REASON FOR HAVING A QDRO
The most common reason for parties to have a Qualified Domestic Relations Order (QDRO) is to divide retirement benefits due to divorce or legal separation. Most retirement plans require a QDRO, or similar court order, before benefits can be paid from the plan to an alternate payee (non-employee former spouse of the plan participant). However, there are other benefits to QDROs that are sometimes overlooked. For instance, the parties may consider an equalization of other assets in order to avoid the necessity of preparing a QDRO, but QDROs can provide additional benefits that other property equalizations cannot.
TAX BENEFITS OF QDROs
One of the main tax benefits of a QDRO is the exemption from the early distribution or premature withdrawal penalty. We have previously elaborated on these tax benefits in this blog post. For California residents, the QDRO exemption under IRC §72(t)(2)(c) will typically save approximately 12% in combined state and federal taxes on any distributions made pursuant to a QDRO prior to the alternate payee reaching age 59 ½. Note – the exception to the early withdrawal penalty only applies to distributions made to a former spouse from a qualified retirement plan under a QDRO. There is no divorce exception to the 10% additional tax on early distributions from IRAs because IRAs are not qualified retirement plans.
QDROs & LIQUIDITY
Due to restrictions on distributions built into many retirement plans, the participant cannot receive any funds until reaching the plan’s earliest retirement age. However, for some plans, QDROs will allow benefits to be distributed to an alternate payee prior to the date that such distribution would be available for the participant. This can assist in providing the alternate payee with the necessary liquidity due to other property equalizations, such as buying out the participant’s interest in the family home. (See IRC §414(p)(4), (9); Treas Reg §§1.401(a)-13(g), 1.409A-2-1.409A-3)
BANKRUPTCY, TAX LIEN AND CREDITOR PROTECTION UNDER QDROs
Assets held under qualified retirement plans are usually exempt from the bankruptcy estate (11 USC §522). The alternate payee’s share of the benefits can also be protected from tax liens against the participant (U.S. v Taylor (8th Cir 2003) 338 F3d 947). QDROs can also protect assets from other creditors under Cal. Civ. Proc. Code §704.115, with some exceptions, such as enforcing orders under the Mandatory Victims Restitution Act, as in U.S. v. Novack.
PREVENTING LOSS OF BENEFITS ON PARTICIPANT’S DEATH
As mentioned in our “When Should I File My QDRO?” blog, if a QDRO is not filed and a participant dies, the alternate payee may lose his/her entire interest in the retirement benefits. For example, if a participant dies while unmarried and while still working, there may be a “Qualified Pre-Retirement Survivor Annuity” or “QPSA” available. A QDRO could secure all or a portion of the QPSA benefits for the former spouse of the participant in such a case. QDROs can also ensure that a former spouse will receive all or a portion of other survivor benefits paid upon the participant’s death, including those paid if the participant dies after retirement.
DO YOU NEED A QDRO?
If you have questions about the division of retirement benefits due to your California dissolution of marriage or legal separation, or if you would like to get started on your Qualified Domestic Relations Order today, please call QDRO Helper at (619) 786-QDRO / (619) 786-7376. You can also request a new client package by sending an email to firstname.lastname@example.org. We proudly assist clients throughout the United States as long as the divorce or legal separation took place in California.
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