If you’ve made it through the qualified domestic relations order (QDRO) drafting process, and both parties have agreed to sign, you’re probably wondering what happens when you find that pot of gold at the end of the rainbow. You will have three options after the court has signed the order and you’ve returned it to the plan: cash it out, roll it over to another plan, or park it in a new account with your current provider.
There are three main options for the alternate payee (the person who receives the benefit): cashing out, rolling over, or leaving it with the existing retirement plan provider.
Cashing out means that the alternate payee receives a lump sum payment of their share of the retirement plan. This option may seem attractive for those who need immediate cash or have other financial goals. However, there are some drawbacks to consider:
- The alternate payee will have to pay income taxes on the amount received, unless they qualify for an exception.
- However, the alternate payee will likely NOT have to pay a 10% early withdrawal penalty if they are under 59 1/2 years old, as there is a QDRO exemption to that penalty.
- The alternate payee will lose the opportunity to grow their retirement savings through compound interest and tax-deferred earnings.
Rolling over means that the alternate payee transfers their share of the retirement plan to another retirement account, such as an IRA or another employer-sponsored plan, such as a 401(k). This option may be preferable for those who want to preserve their retirement savings and avoid taxes and penalties. However, there are some factors to keep in mind:
- The alternate payee will have to pay taxes and penalties when they eventually withdraw the funds from the new account.
- The alternate payee will have to monitor and manage their new account and make sure it aligns with their risk tolerance and retirement goals.
- The alternate payee will not have immediate access to the funds and will have to wait to withdrawal the funds until they reach retirement age, unless they want to pay an early withdrawal penalty, as the QDRO exception only applies if you withdrawal at the time of the QDRO.
Parking it is where the alternate payee leaves their share of the retirement plan in a new retirement account with the current provider. This option may be preferable for those who do not have time to locate a new financial institution, and who want the easiest path towards saving for retirement, but not all plans will allow it (though most private plans will). However, there are some factors to keep in mind:
- The alternate payee will have their own account, completely separate from the participant-employee, but some people prefer the idea of keeping their funds in a separate bank altogether.
- Not all retirement plans will allow this. Some government plans will not maintain a new account for a non-employee and will require the alternate payee to cash out or roll over.
The choice between keeping your funds at the same institution, cashing out, or rolling over depends on the individual circumstances and preferences of the alternate payee. There is no one-size-fits-all answer. Therefore, it is advisable to consult with a financial planner and a tax professional before making a decision. A QDRO can have significant implications for both parties’ financial future and well-being.
