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Dividing a 401(k)

On Behalf of | May 9, 2024 | Divorce, Property Division

Splitting assets can be a complicated process during a divorce in California. It can be difficult to determine how much assets cost and how certain assets should be sold. These worries are magnified when there is a 401(k) account involved. Divorcing couples must take careful steps to ensure that they do not suffer substantial penalties when these types of assets are split.

Why it matters

A 401(k) is a tax-advantaged account that allows individuals and couples to put money away to prepare for retirement. It is an asset that usually cannot be accessed early without incurring a significant penalty. That penalty applies whenever people withdraw money from an account. With most assets related to divorce, such a withdrawal is relatively simple in the property division process.

But with a 401(k), a withdrawal can incur a significant penalty. People who withdraw from 401(k)s have to pay both a penalty tax and taxes on the income generated by the account that would have otherwise been deferred. In some instances, these amounts can be in the thousands of dollars and can take a substantial dent out of a retirement account.

What to do

Instead of simply withdrawing the money, divorcing couples need to look into drawing up a qualified domestic relations order (QDRO) letter. This letter comes from a court or state agency and tells the bank or financial institution involved that the individual in question is simply trying to split assets from a divorce.

If a person obtains this letter and then keeps the money in the two new accounts, there will be no associated penalties. Couples should work with legal professionals to make sure they meet all of the qualifications of this QDRO. But if they do, they can overcome any potential tax hurdles associated with this complicated financial split.