When a client is going through divorce, their accountant is often the most consistent advisor in the room. With so many Americans stuffing their employer-sponsored retirement plans to the gilt, one of the most critical issues in divorce is the proper handling of retirement assets — particularly those subject to qualified domestic relations orders (QDROs).

In New Jersey, where equitable distribution rules meet complex federal tax law, accountants are uniquely positioned to protect clients from costly missteps. It’s important to understand the key tax considerations, pitfalls and state-specific issues surrounding QDROs so that you can bring clarity where others bring confusion.

Understanding the QDRO Framework

A QDRO is a domestic relations order that creates or recognizes an alternate payee’s right to receive all or part of a participant’s retirement benefits under a qualified plan. These are plans governed by the Employee Retirement Income Security Act of 1974 (ERISA), importantly this does not include IRAs.

Under IRC §414(p), a QDRO must (1) relate to child support, alimony or marital property rights; (2) be made pursuant to a state domestic relations law; and (3) be accepted by the plan administrator. A divorce decree alone is not enough. Failure to secure plan administrator approval can nullify tax protection.

Tax Treatment: Timing Is Everything

When structured correctly, a QDRO allows for early distributions from a retirement plan to an alternate payee without triggering the 10% penalty under IRC §72(t)(2)(C). However, those funds are still taxable as ordinary income to the recipient unless rolled over to another qualified plan or IRA.

In one example, the court in Darby v. Commissioner, 97 T.C. 51, held that a taxpayer who withdrew retirement funds for his ex-wife before a QDRO was in place remained liable for the tax and early withdrawal penalty, even though the funds were ultimately meant for his former spouse. Thus, clients navigating a divorce should never move funds before the QDRO is approved by the plan; and when funds are moved, make sure the receiving spouse rolls it over into an IRA or other qualified plan.

New Jersey-Specific Issues

New Jersey follows equitable — not equal — distribution. Retirement accounts accrued during the marriage are generally marital property under N.J.S.A. 2A:34-23.1, but how they are divided can vary. CPAs should pay close attention to:

• Valuation dates: The date of the complaint versus date of distribution can create significant tax timing issues — particularly in volatile markets.
• Immediate offsets: Trading a retirement account for another asset (e.g., home equity) ignores the deferred tax burden of the retirement asset, leading to unequal post-tax outcomes.
• Survivor benefits: In defined benefit plans, the QDRO must address survivor annuity rights under IRC §417. Failure to do so can eliminate the alternate payee’s benefit if the participant dies.

Common Mistakes to Avoid

• Assuming IRAs require QDROs: They don’t. Transfers incident to divorce from an IRA are governed by IRC §408(d)(6) and must be executed via trustee-to-trustee transfer. Mistakes here result in taxable events.
• Ignoring plan-specific procedures: Every ERISA plan has its own QDRO approval process. Accountants should ask for the plan’s QDRO guidelines early, particularly in defined benefit plans where distribution options are limited.
• Improper rollovers and withholding: If the alternate payee takes a lump sum distribution, a mandatory 20% withholding may apply. A direct rollover avoids this. Educate clients on the difference between a rollover and a taxable distribution.

Practical Tips When a Client is Going Through a Divorce

• Engage early: Don’t wait until after the decree. Your insight can shape negotiations, especially regarding pre-tax versus after-tax asset values.
• Coordinate with counsel: You don’t need to draft the QDRO, but your review can catch financial errors that attorneys may miss.
• Model after-tax outcomes: Use post-tax value comparisons when helping clients consider trades like, “you keep the house, I’ll keep the 401(k).”
• Document everything: If you advise on the tax consequences of a proposed division or draft QDRO language, retain your notes and written recommendations.

Be the Advisor Who Sees Around Corners

The intersection of divorce, retirement assets and tax law is a minefield — but one that CPAs are uniquely equipped to navigate. In New Jersey, where equitable distribution and federal tax law often clash, QDROs are not just legal documents — they’re critical financial tools.

CPAs who understand the real-world impact of Darby, IRC §§72(t), 408(d)(6) and 414(p), and who proactively coordinate with counsel, don’t just save clients from tax headaches — they earn a reputation as indispensable advisors.