Valuing and dividing retirement accounts is more complex than most attorneys expect. An experienced financial professional can provide ideas to help divide these accounts strategically – and avoid unnecessary costs.

By Pam Friedman, Divorce Financial Analyst

1. Can a retirement account be divided without triggering taxes?

Retirement Accounts and DivorceA tax-free division is possible, but each plan or account has different requirements. Without the right process, clients may be subject to significant taxes, penalties, expenses and ultimately an un-equitable division.

While the division of marital property is generally governed by state domestic relations law, any assignments of qualified retirement interests – for example, a 401(k) plan or pension plan – must also comply with Federal law, namely the Employee Retirement Income Security Act of 1974 (ERISA) and the Internal Revenue Code of 1986 (the Code).

The most common error that triggers taxes is a withdrawal of account resources before age 59.5. With limited exceptions, the withdrawal incurs taxes and a 10% penalty. Because tax rules and the process of dividing accounts can change, you should consult with a financial and/or tax advisor who specializes in divorce issues to ensure your information is current.

An employer provided qualified retirement plan will require a Qualified Domestic Relations Order (QDRO, pronounced “Quadro”) to divide the investments in the account.  If prepared properly, the QDRO outlines every detail of the split so the plan administrator can complete the transaction accurately.

Many attorneys downplay the need for a QDRO specialist. They often use standardized QDROs or one made available by plan administrators. However, these templates may not include all options for division. A QDRO specialist should be able to explain and explore options. The specialist can better assure that the QDRO is prepared accurately, money is divided in a timely fashion and is divided in a manner that avoids taxes.

Many traditional IRAs or Roth IRAs may not require a QDRO. Often, division requires a copy of the divorce decree, and specific forms provided by the custodian (Fidelity, for example).  This requires participation from the existing account holder and their spouse, plus each spouse’s financial advisor or custodian. Ideally, get these documents in advance. Have couples sign as many transfer forms as possible at the same time the decree is signed.

2. Is a retirement plan more or less valuable when compared to other assets?

QDRO and DivorceRetirement assets are only one part of a family’s total financial picture. The keys to starting a new financial life beyond divorce include liquidity, expense reduction, and tax avoidance. A divorce financial professional can help clients rate each asset for liquidity and tax consequences to better suit financial goals and priorities. They will also prepare income and expense projections to see how long the client’s resources will last.

Most retirement plans rank lower than other assets because withdrawals are taxed at the owner’s highest marginal tax rate and incur a 10% penalty until age 59.5 (although there are exceptions).

What about the sale of a home? Assuming there is a market for the residence, home sale proceeds nearly always rank high on the list of desirable assets. Usually, a large share of the gain from the sale of a primary residence (after closing costs are paid) is not taxed and, unlike most retirement plans, these proceeds are available to divorcing clients before age 59.5 without penalty. By comparison, keeping an unaffordable house greatly diminishes liquidity – and may result in a forced a sale at a lower, fire-sale price.

Cash savings and checking accounts are, obviously, the most liquid. Brokerage and investment accounts rank in-between home sale proceeds and most retirement accounts because they are available for withdrawal and only the investment gains (generally sales price less cost) are taxed. Missing the tax impact of selling long-term investments in a taxable non-retirement account can result in an unequitable division.

3. Can you avoid the IRS penalty for early withdrawal in divorce?

When the receiving spouse is awarded a share of a qualified plan like a 401(k), the share is most often moved to an alternate payee account inside the plan. Under IRS rule 72(t)(2)(C), the alternate payee of a qualified plan can withdraw funds pursuant to divorce without the 10% early withdrawal penalty, but ordinary income taxes will still need to be paid. For a spouse with little or no income in the first year of divorce, this can be a source of much-needed cash. 

But remember that the 10% penalty waiver is only in case of divorce. Normally, the penalty acts as a disincentive to use retirement funds for current expenses. Investments benefit from long-term compounding gains to cover our expenses when we are no longer able to work. Attorneys and clients should explore all potential sources of liquidity before recommending the use of these proceeds.  

The plan administrator of a qualified plan will withhold 20% of the withdrawal from a qualified plan for taxes (even when the spouse’s expected marginal tax rate is lower). The tax expense can be more costly than expected when the plan does not permit partial withdrawals and the alternate payee withdrawal is significant. The more the spouse withdraws, the higher taxes owed. However, if done properly, even a 100% withdrawal can avoid some taxes and penalties by contributing excess cash proceeds to an IRA within 60 days.

Again, proceed with caution as tax rules can change. Since every situation is unique, consult a CPA about the intent to use a penalty-free withdrawal before finalizing a settlement agreement.

4. Should you “tax affect” retirement accounts when dividing assets in divorce?

Grey DivorceMany attorneys will “tax affect” retirement plans: discounting an account’s value by the recipient’s highest marginal tax rate. Left unchecked, the spouse receiving more of the retirement accounts may benefit (possibly unfairly) in negotiations from this practice.

In order to properly discount each plan or account based on real economics, the parties would need to know when and how much will be needed for living expenses, future tax rates for each party and the rate needed to discount the tax expense back to today’s dollars – even when the recipient is very close to retirement. 

For example, say an employee spouse has been working for his company for more than ten years. His tenure and skills make it probable that he will be employed through to retirement. Discounting his retirement at his highest marginal tax rate as if he would take the full amount today may reduce the amount his spouse receives in divorce. If he is unlikely to need retirement funds, perhaps the discount is much lower than it is to his highest marginal tax rate.

By preparing financial projections, an experienced financial professional may be able to assess the amount and timing of the recipient’s anticipated withdrawals from retirement accounts. This can support an analysis of whether and how much to “tax affect” or discount the value of retirement assets.


Preparation is essential to a successful and cost-effective division of retirement accounts. Retirement plans are complex because of ever-changing tax rules and legislation. Attorneys can minimize their risks by hiring the right professionals before their clients get into serious negotiations or sign settlement agreements. 

Pam Friedman (CFP®, CDFA™) is the founder of Divorce Planning of Austin and a partner at Silicon Hills Wealth Management. She is the author of I Now Pronounce You Financially Fit: How to Protect Your Money in Marriage and Divorce (River Grove Books, 2015).

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