When it comes to dividing 401(k) assets during divorce, special care must be taken to ensure that that the divorcing parties do not run afoul of the law. Specific steps must be taken through proper channels to avoid unnecessary tax burdens and other penalties.
Liquidating 401(k) assets must be done with the permission of the court through a judge signing a Qualified Domestic Relations Order. The QDRO entitles the receiving party to a certain portion of the assets, while protecting the owner of the account from being hit with early withdrawal penalties or tax burdens when withdrawing the assets to be given to other spouse.
Spouses receiving a 401(k) distribution subsequent to a divorce can access the funds in three ways. Firstly, the recipient may choose to roll over assets from the distributor's account into his or her own qualified retirement plan. This can be accomplished through a direct transfer, which will bypass penalties. Secondly, the receiving spouse may also choose to wait until the account owner retires, at which time he or she may accept regularly scheduled payment, or a lump sum. Thirdly, but most costly, a recipient may choose to cash out one's portion of the assets. For those who have not yet reached 59 1/2 years of age when the cash-out takes place, there may be income tax implications in addition to the standard 10 percent early withdrawal penalty.
It is generally acceptable for couple to work out an agreement between themselves, which the court will honor, provided that it is not deemed unreasonable to either party. While it is possible to navigate these complicated procedures on one's own, the assistance of a qualified attorney can help ensure that not assets are needlessly left on the table, while helping to protect the rights of all parties.
Source: Dowan Law Offices, "Divorce," accessed Aug. 04, 2016