With the exception of those spouses with substantial assets, often the largest asset divorcing spouses have in Colorado is their 401K, IRA, and other retirement accounts. Colorado is an “equitable distribution of marital assets” divorce state. When spouses divorce in Colorado, the state compels them to fully disclose their financial assets and divide any marital assets in a way that’s fair if not exactly 50/50. When it comes to a retirement account, often one spouse is surprised to learn that the retirement savings they accumulated through their employment and in only their name belongs equally to the other spouse even if the spouse’s name is not on the account, and they did not contribute to the savings.
When divorcing spouses divide their marital assets, Denver property division attorneys commonly seek a Qualified Domestic Relations Order (QDRO) from the Colorado courts to distribute a client’s share of a 401K or other retirement account with a spouse with the best options for avoiding expensive penalties and taxes.
Why Do I Have to Share Retirement Savings From my Job With My Spouse?
It’s easy to think of your 401K or IRA account as belonging solely to you if it’s a benefit of your employment, your name is alone on the account, and the contributions come from your sole earnings; however, any assets accumulated during the marriage belong to both spouses equally in Colorado regardless of whose name is on the account. In theory, this is because you might not have been able to contribute to the account had your spouse not also worked and contributed to the household or stayed home and raised the children to free you to continue focusing on earning for the household.
Whether or not you agree with the theory, Colorado family courts compel spouses to divide all marital debts and assets, and 401K and other retirement savings are important assets subject to equitable distribution during divorce.
How Does a Qualified Domestic Relations Order Help Split a Retirement Account?
Upon learning that a spouse is entitled to half of a 401K or IRA, some divorcing individuals may opt to immediately cash out the account and hand over half to their spouse; however, cashing out a retirement account comes with tax penalties for the receiving spouse and may result in significant early withdrawal penalties for the account holder. In some cases, cashing out a retirement account can reduce the amount by as much as 40%. A QDRO is a court order issued during the divorce process to alleviate tax burdens and early withdrawal penalties. A QDRO allows the following options for transfer:
- A direct rollover of the spouse’s share into their existing IRA or an IRA account they open for this purpose
- A new 401K or IRA account opened by the plan holder in the spouse’s name to roll over their share of the plan holder’s account
- A partial lump-sum distribution of the amount distributed to the spouse with a rollover of the remainder into an IRA. The amount of the distribution in this case is subject to income tax
- A full lump-sum distribution issued to the spouse. This is subject to income tax as well as a 10% penalty for early withdrawal if you are over the age of 59.5
It’s always best to speak to your Denver divorce attorney and a financial advisor about your options before making a decision. In some cases, if both spouses have equal amounts in separate 401K or other retirement accounts, a judge could decide that each spouse keeps their own account rather than using a QDRO to split and redistribute both accounts.