Using QDRO Money from a Divorce to Pay for a New Home

Understand the tax implications first so you can plan properly

When couples divorce, assets are usually divided. However, that asset split doesn’t automatically extend to retirement plans. This is where a qualified domestic relations order (QDRO) can come into play. A QDRO is a court order used to divide the assets that are in specific types of retirement plans, including 403(b) and qualified plans, such as 401(k)s. But if you want to use that money—for example, to buy a house—there are several points to consider first, including the tax implications.

Key Takeaways

  • A qualified domestic relations order (QDRO) is a court order used to divide certain retirement-specific assets during a divorce.
  • Assets distributed from a qualified plan under a QDRO are exempt from the usual 10% early withdrawal penalty.
  • But because the qualified plan assets you receive under a QDRO are rollover-eligible, amounts that are paid directly to you instead of to an eligible retirement plan will be subject to mandatory withholding.

Can You Use a QDRO to Buy a House?

You can use the funds distributed from a qualified plan under a QDRO to buy a home, but it's important to understand the distribution options and tax implications of each.

Assets distributed from a qualified plan under a QDRO are exempt from the usual 10% early withdrawal penalty. So, if you are under age 59½ and want to use any portion of these assets immediately, you may not want to roll over that portion of the assets to an IRA. Funds rolled over to a traditional IRA that are distributed from that IRA are subject to the 10% penalty, unless you meet an exception.

If you're not going to use all of the money right away, you could have a portion of the amount processed as a direct rollover to your traditional IRA and the balance paid to you. The amount that is processed as a direct rollover to your IRA will not be subject to withholding tax.

Because the qualified plan assets you receive under a QDRO are rollover-eligible, amounts that are paid directly to you instead of to an eligible retirement plan will be subject to mandatory withholding. This withholding is 20% for federal taxes and an additional amount for state taxes depending on where you live. Therefore, you may want to ask for an increase in the distribution amount to ensure that the net amount you receive is enough to buy your new home.

The spouse who is on the receiving end of their portion of the retirement assets should file the QDRO.

QDRO Distribution Options

Unless you need some of the money immediately, you may choose to roll over the assets to your traditional IRA and have the distributions paid to you over time. Amounts paid to you for at least five years or until you are age 59½—whichever is longer—are exempt from the 10% early-distribution penalty, provided the payments meet certain requirements.

This is commonly referred to as substantially equal periodic payments or 72(t) distributions. If you end up considering this option, make sure you know how much you'll be getting each year.

If you want to convert the assets to a Roth IRA, you must first roll over the funds to a traditional IRA. The funds can then be converted from the traditional IRA to the Roth IRA. However, you should know that you will owe taxes on the converted amount for the year the conversion occurs.

Some qualified plans will not distribute assets under a QDRO until the plan participant—in this case, your former spouse—experiences a triggering event, such as reaching retirement age or being separated from service with an employer. Others consider the QDRO a triggering event.

The Bottom Line

Don't assume that retirement account assets roll up into your divorce settlement. These assets need to be addressed separately. Be sure to carefully consider how and when you'd like to be able to use these funds since a mistake could result in unwanted tax penalties. Also, if the retirement plan is a qualified plan make sure you know whether there are any distribution limitations.

Can You Buy a Home With QDRO Distributions?

It is possible to purchase a home with QDRO distributions, but it's crucial to understand the tax implications first. Assets distributed from a QDRO are exempt from a 10% early withdrawal penalty on any funds withdrawn if the person is under the age of 59½. But any amount that is paid directly to you instead of being rolled over to an eligible retirement plan will be subject to a mandatory withholding tax.

Which Retirement Plans Are Subject to a QDRO?

A QDRO is a court order used to divide specific types of retirement plans, including qualified plans, such as a 401(k), and 403(b) plans. A QDRO must comply with the Employee Retirement
Income Security Act (ERISA)
. ERISA provides a regulatory framework for employer-sponsored retirement plans to protect participants and their beneficiaries. IRAs are not subject to ERISA and are divided using a process known as "transfer incident to divorce."

How Do QDRO Distributions Work?

There are several options for QDRO distributions. You can take the funds as a lump sum but will be subject to a mandatory withholding tax, which is 20% for federal taxes. You may also be subject to state taxes depending on where you live. A receiving spouse can also roll QDRO assets into their own qualified plan or into a traditional or Roth IRA. If converting the assets to a Roth IRA, the funds must be rolled over to a traditional IRA first and you’ll be taxed on the converted amount. Another option is to roll over the assets to a traditional IRA and take distributions over time, which is known as substantially equal periodic payments or 72(t) distributions.

Article Sources
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  1. United States Code. "26 USC §72(t)(2)(C)."

  2. Internal Revenue Service. "Retirement Topics—Exceptions to Tax on Early Distributions."

  3. Internal Revenue Service. "Retirement Topics—QDRO—Qualified Domestic Relations Order."

  4. Internal Revenue Service. "Topic No. 412 Lump-Sum Distributions."

  5. U.S. Department of Labor. "QDROs: The Division of Retirement Benefits Through Qualified Domestic Relations Orders," Page 17.

  6. Internal Revenue Services. "Retirement Plans FAQs Regarding Substantially Equal Periodic Payments."

  7. Internal Revenue Service. "Publication 590-A: Contributions to Individual Retirement Arrangements," Page 27.

  8. U.S. Department of Labor. "QDRO's - An Overview."

  9. Internal Revenue Service. "Publication 504 (2020), Divorced or Separated Individuals."

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