Qualified Domestic Relations Orders provide an exception to the general rule that once you have deposited money into a retirement account, you cannot withdraw it or transfer it without incurring a penalty and paying taxes on the amount withdrawn or transferred. These are orders that are available in divorce cases, or incident to a divorce. They can be very useful in a variety of ways.
The most common use is equalizing the amount of retirement funds that each spouse will take from the marriage. For example, let's assume wife has $200,000 in retirement money and husband has $100,000 in retirement money. In divorce, we want to equalize the property that each spouse is taking from the marriage. Let's also assume that all of this retirement money was earned during the marriage. In order to equalize these accounts, wife can transfer $50,000 to husband by way of a QDRO. Each will end up with $150,000 in retirement funds. The transfer from wife to husband will not be subject to tax or penalty. Depending on the plan requirements, husband may be able to keep the money on deposit with wife's retirement plan or role the money into an IRA, without incurring any taxes. However, if husband withdraws the money, he will have to pay taxes on the money at his rate, since now the money belongs to him. If the money is being transferred from an employer provided plan, any such withdrawal will not be subject to the penalty.
Another use for QDRO's is to pay off debt that the couple has incurred during the marriage which they cannot afford to pay off using their after tax funds. For example, let's assume the couple has $30,000 in credit card debt. Husband has a retirement fund of $200,000. Wife has a fund of $60,000. In order to equalize the funds, husband should transfer to wife, $70,000. Husband can transfer an additional $15,000 to wife to pay off his share of the credit cards and wife can use $15,000 of her transferred money to pay off her share of credit card debt. However, there is another wrinkle. Money in retirement funds has not yet been taxed. When wife withdraws the $30,000 to pay the credit card debt, she will owe tax on that money. Let's assume her tax rate is 20% federal and state. Husband should transfer an additional $3,000 to her to cover his share of her taxes on the amount he is paying towards the credit card debt. Wife should set aside an additional $3,000 towards her share of the withdrawal on the credit card debt. There is no penalty for this withdrawal. After the debt is paid, both parties can look forward to being debt free and having an equal amount of retirement.
This can also work if the holder of the retirement funds wishes to withdraw money for a down payment on a new residence. He or she can transfer the funds from their retirement account, plus the appropriate amount of taxes to the opposing spouse, who will agree in writing, to transfer the net amount back to the spouse who needs the money for the down payment.
Another use for QDRO's is using retirement money to pay impending or delinquent child support. For example, let's assume father of two children does not want the added financial obligation of paying child support. We can calculate the amount that he would owe mother until the child support obligation is satisfied. He can transfer that amount, plus the percentage that mother would incur in taxes when she needs to withdraw the amount of the child support. A QDRO for the combined amount can transfer a lump sum to mother, who will use the money as child support.
Sometimes, a QDRO can also be used to satisfy one spouse's alimony or spousal support obligation. For example, former husband owes wife 3 more years of spousal support. However, he wants to retire early. He has sufficient funds in his retirement account to pay her a lump sum and satisfy his obligation. We can present value the remaining spousal support and transfer that amount to former wife.
An obvious drawback to withdrawing funds from a retirement account is that the money will not be there to support the account holder in retirement. Therefore, this should be done with caution and after consulting with your financial advisor. However, there are times when your priority is to pay off your debts or purchase a home or catch up or avoid child support/spousal support. Consult with your attorney and consider the QDRO as an option.