Post-Divorce QDRO 401(k) Split: RMD Complications for an Ex-Spouse

Divorce can complicate life in any number of ways. After a couple splits, they typically must also split up their retirement assets. Using a qualified domestic relations order, or QDRO, can be critical to getting that split right and avoiding future problems and headaches. What's surprising for many is that using a QDRO to divide up qualified retirement plan assets doesn't always create the clean split that they expect—and that a former spouse can continue to impact a client's rights and obligations with respect to required minimum distributions (RMDs) for years to come. Understanding the rules governing retirement accounts under a QDRO post-divorce can be critical to avoiding steep penalties for missed RMDs. The IRS rules aren't what many clients will expect, so it's important to dig into the details and options whenever a client decides to divorce.
QDROs and the RMD Rules
ERISA-governed retirement plans typically will not allow a plan participant's ex-spouse to obtain the participant's retirement funds unless they follow the correct possible. That's true even if the divorce settlement grants a portion of the participant's retirement assets to the ex-spouse.
Assuming the participant withdraws the funds to satisfy their divorce settlement obligations, the tax consequences can be significant. Without a QDRO, the withdrawal can trigger the 10% early withdrawal penalty and will be fully taxable.
These tax consequences can be avoided with a QDRO that satisfies federal ERISA requirements. The ex-spouse's portion of the retirement account is transferred into a separate account within the plan, in the ex-spouse's name.
Complications can arise when it comes to calculating required minimum distributions. RMD obligations are typically triggered with the participant reaches their required beginning date (currently, 73 and 75 for taxpayers born after 1959). Under IRS regulations, the participant's age continues to govern RMD obligations for the ex-spouse's separate account.
In other words, the ex-spouse must begin taking RMDs at the same time as the original plan participant, regardless of their age and regardless of how long they've been divorced. The ex-spouse will use their own life expectancy to calculate the annual RMDs.
Missing an RMD can carry significant penalties. The SECURE Act 2.0 reduced that penalty to 25% of the missed RMD effective for 2023 and beyond. The penalty may be further reduced to 10% of the missed RMD if the taxpayer takes all of their missed RMDs and files a tax return paying the required tax and penalty amount before the earlier of (1) receiving a notice of assessment of the RMD penalty tax or (2) two years from the year of the missed RMD.
The IRA Rollover Option
An ex-spouse who is younger may wish to delay RMDs. That's especially true if they're significantly younger than the plan participant and are still in a relatively high tax bracket. It's often beneficial to delay RMDs until retirement, when an individual may have dropped into a lower tax bracket.
To avoid taking RMDs based on an ex-spouse's age, an individual can roll the funds from a QDRO separate account into a traditional IRA in their own name. IRAs are not governed by ERISA. Once the funds are in the IRA, RMD obligations depend on the individual account owner's age alone (although any ERISA-mandated RMDs for the year-of-rollover must be taken before the rollover can occur).
Once the funds are rolled over into the IRA, they become subject to all of the generally applicable IRA distribution rules. The early distribution penalty may be factor if the individual is under age 59 ½ and needs access to the funds. While the funds in the QDRO-created separate account would not be subject to the early distribution penalty even if the ex-spouse was under age 59 ½, they do become subject to possible penalties once they hit the IRA.
Conclusion
The RMD rules have become significantly more challenging in recent years—and it's easy to overlook the specific complications that a QDRO can create. After all, QDROs are complicated legal documents themselves. Anytime a client divorces, it's critical to review the rules governing their RMD obligations so that they avoid potentially steep penalties for missed RMDs down the line.