Blog Author: Stephen C. Hartnett, J.D., LL.M. (Tax), Director of Education,
American Academy of Estate Planning Attorneys, Inc.
Transferring an ERISA account, like a 401(k), from one spouse to another can have substantial tax benefits, by delaying Required Minimum Distributions or avoiding early withdrawal penalties. However, one cannot simply transfer an account from one spouse to another under most circumstances without triggering adverse tax consequences. A Qualified Domestic Relations Order or “QDRO” avoids those adverse consequences. While a QDRO is most commonly used in a divorce context, divorce is not a requirement. Read on to learn more.
A Qualified Domestic Relations Order (“QDRO”) is part of federal law that allows a domestic relations order in state court to transfer ERISA accounts, such as 401(k)s, from the spouse who is the “participant” in the plan to the other spouse without triggering a tax event. Typically, a QDRO is done in the context of a divorce of the spouses. However, there is nothing that limits a QDRO to the divorce context.
Stephanie Prestridge and Marcus Foote with In Marriage QDRO, LLC, which pioneered the “In Marriage QDRO®,” say it has been used in many jurisdictions throughout the United States since it is based on federal law. The In Marriage QDRO® interweaves the ability of married spouses to contract between themselves with the benefits of federal QDRO law, in order to transfer 401(k) or other ERISA assets out of the name of the participant spouse and into the name of the other spouse without adverse tax consequences. The In Marriage QDRO® has, in effect, created an additional event without adverse tax consequences, one that a married couple can plan, control, and trigger through the use of the agreement and court order.
The In Marriage QDRO® has many possible uses in estate planning. Depending upon the circumstances, it could be used, among others, to do the following:
- Delay the implementation of Required Minimum Distributions (RMDs),
- Allow movement of the ERISA plan for Medicaid planning for long-term care cases, or
- Avoid suffering the 10% early withdrawal penalty and provide penalty-free access to the funds for emergencies or other needs.
For example, let’s say the participant spouse is 70 years old and will soon be forced to begin taking Required Minimum Distributions from their 401(k) upon reaching age 70 ½. If the other spouse is only 61, an In Marriage QDRO® could transfer the plan to the other spouse and delay taking any Required Minimum Distributions for another 9 years. Similarly, if the couple wanted to transfer assets to the other spouse as part of a Medicaid long-term care plan, the In Marriage QDRO® could allow for that without liquidating the plan and facing adverse tax consequences prior to the transfer of the funds.
Let’s look at another couple, with a participant spouse age 56 and the other spouse age 60. The couple has financial issues and needs to access the funds in the participant spouse’s 401(k). However, withdrawals before age 59 ½ would face a 10% early withdrawal penalty. An In Marriage QDRO® could transfer the portion of the participant spouse’s 401(k) which the couple needs to access to the other spouse who is age 60. Since that spouse is past age 59 ½, the 10% early withdrawal penalty would no longer apply.
Although the application of the In Marriage QDRO® is relatively new, the foundations for the strategy have been in federal law since 1984. The strategy, and federal QDRO laws, allow the ERISA retirement plan to go to an “alternate payee,” including any spouse, former spouse, child, or other dependent of the participant in the plan who is recognized by the domestic relations order as having a right to receive all, or a portion of, the participant’s plan. This would allow a tax-free transfer to the other spouse as alternate payee. Then the IRS withdrawal rules would apply to the other spouse as alternate payee as though they had been the participant. Thus, as a 61-year-old, the other spouse as alternate payee wouldn’t have to begin taking distributions until reaching age 70 ½.
For more information, see Internal Revenue Code sections 26 USC 414(p) and 29 USC 1056(d)(3).
The Litherland Law Firm is a member of the American Academy of Estate Planning Attorneys. If you would like to learn more about the importance of estate planning, we invite you to attend one of our free estate planning seminars.