During divorce proceedings many things are subject to being divided; the marital home, the kids, credit card debt and yes, investments one or both of you may have such as a 401(k) or an Individual Retirement Account. It is important to understand how the division works whether you are on the giving or receiving end.
Today retirement accounts are often valued more than the marital home, the once most fought over asset. With declining home values and high dollar mortgages the marital home may not be your largest asset in divorce. Since retirement accounts are valuable assets it is important to make sure they are dealt with properly to avoid unforeseen or undesirable tax ramifications.
What’s a QDRO got to do With It?
Division of a 401(k) plan and many pension plans require a Qualified Domestic Relations Order (QDRO).
According to the Internal Revenue Service, “A QDRO is a judgment, decree or order for a retirement plan to pay child support, alimony or marital property rights to a spouse, former spouse, child or other dependent of a participant. The QDRO must contain certain specific information, such as; the participant and each alternate payee’s name and last known mailing address, and the amount or percentage of the participant’s benefits to be paid to each alternate payee.”
In laymen’s terms, a QDRO is a legal document included in a divorce-related property settlement or divorce decree. The goal is to establish ownership and transfer of qualified plan funds without tax ramifications. If you are awarded part of a distribution from a qualified retirement plan you may be able to roll over the funds tax-free. If you are receiving QDRO payments from your ex you may also be able to roll those over just as if you were the employee receiving the funds and opting to roll them over.
A few things to remember about QDRO’s:
- Have them prepared by your attorney or qualified QDRO professional.
- A QDRO must be completed and presented to the plan provider in advance of your divorce being finalized.
- Try to have your QDRO issued as close to the divorce finalization as possible.
The Division of IRA’s
You don’t need a QDRO to divide IRA accounts, but dotting I’s, crossing T’s, and working with your attorney or tax professional is a must do. Here are a few things to keep in mind:
- If you are the one giving up the funds, you can roll over money tax-free from your IRA to an IRA set up for your ex, IF it is set up as part of your divorce property settlement.
- If you are receiving the funds you can manage the IRA and defer taxes until money is withdrawn (hopefully at retirement). At that point, your ex, not you will owe the taxes.
- Your settlement agreement should read, “Any division of property accomplished or facilitated by any transfer of IRA account funds from one spouse or ex-spouse to the other is deemed to be made pursuant to this divorce settlement and is intended to be tax-free under Section 408(d)(6) of the Internal Revenue Code.”
Spoiler: If you choose not to take the necessary precautions and are on the giving end of this agreement you will be paying the taxes and the 10% penalty if the funds are withdrawn prior to retirement age.
Are Retirement Funds Marital Property?
When my ex and I divorced we decided we would each keep our own individual retirement accounts. Our investments aside from our home and savings accounts were kept separate, but we were both working and earning dollars towards retirement.
In a situation where one spouse stays home caring for the household, kids, etc. their ability to earn retirement savings is zero. While the other working spouse has the capacity to participate in their employer-sponsored 401(k) or have the funds available to contribute to an IRA. So the stay at home spouse earned their portion of retirement savings by doing their part, right? After all doesn’t marriage mean what’s yours is mine, what’s mine is yours?
In most cases retirement funds incurred during marriage are considered marital property. Thus they would be included in the divorce settlement as an asset to be divided.
But, let’s look at another situation. If you or your ex earned retirement savings prior to tying the knot, the asset is considered separate property, meaning it does not have to be included as marital property.
My advice, if retirement funds are involved be sure to consult with your attorney and a tax professional before signing anything. Retirement savings are definitely an asset you want to pay close attention to.
How did you handle retirement accounts in your divorce? Did you miss any of the important nuances associated with them?
The Divorce Coach Says
My ex and I handled our retirement accounts similar to Suzanne. I had a 401(k) from my employer and he had a defined-benefits pension from his employer. We figured out the division of assets at the time of our divorce so we wouldn’t need to split these accounts. It saved some fees at the time, such as the QDRO expert but I have to wonder if it was smartest move. When the stock market took a dive a few years ago, my retirement account lost a significant amount whereas his account, because it’s defined benefits didn’t. With hindsight, I would have had more protection if we just split both accounts.
I also had a small retirement account from a previous employer that was before our marriage. Technically, I think the it’s value as of the date we were married was considered my personal property and any increase in value after our marriage was a marital asset. However, the plan was so small and it was overseas so again we decided we wouldn’t split it and made the appropriate adjustments elsewhere.
I think before you even think about splitting accounts it’s important to get a clear understanding of what is considered marital assets and that can vary by state law.
Suzanne Cramer is a certified credit counselor.
Photo credit: 401kcalculator.org