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Dealing with Retirement Accounts in Divorce

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If you and/or your spouse have one or more retirement accounts, what are some of the considerations you should take into account concerning your retirement accounts in divorce? This information may be a little complicated so be sure to check with a financial advisor or Certified Divorce Financial Analyst (CDFA) with your questions. 

There are basically two types of retirement plans:

  1. Defined Contribution Plans, like IRAs, 401(k)s, 403(b), Thrift Savings Accounts
  2. Defined Benefit Plans, like company pension plans, union pension plans, government pension plan, some annuity plans

What can we do with them?

  • each keep his or her own
  • divide them in part or in whole
  • transfer funds from one or more defined contribution accounts to the lower earning spouse in order to generate some liqudity at a lower tax rate to pay off debts or make a down payment on a house.

The last two options require, in most cases, a court order which allows the Retirement Plan Administrator to transfer some or all of the assets in your retirement plan to your former spouse. If the plan is a private sector employer sponsored plan, then it is qualified under ERISA and the Plan needs what is called a Qualified Domestic Relations Order (QDRO).  Public sector plans also need court orders to divide them.  Individual Retirement Accounts (IRAs) do not need a special court order, but the IRA Administrator will have forms and processes that need to be followed to complete the transfer of the funds.

As long as funds are transferred between former spouses pursuant to a divorce or legal separation and the funds go into another retirement account, then there is not tax on the transfer.  Only when funds are actually taken out of the retirement account will tax be assessed.

Most retirement accounts have not yet been taxed, so when you take out money from them, those distributions will be taxed as income (and if you are younger than 59 1/2, then you will also pay a 10% tax penalty for early withdrawal.  When balancing retirement accounts against other types of assets, tax considerations should be taken into account.  When you receive funds from a qualified plan via a court order, then when you take funds from the account you do not have to pay the 10% early withdrawal penalty.

On defined contribution plans, you can see how much is in the account from a current account statement.   You can agree to divide the balance of these as of a certain dated, plus or minus gains, losses and earnings, or you can agree a set amount to be transferred at the time the Plan gets around to doing the transfer.

On defined benefit plans, you can divide the benefit that will be paid at retirement time.  Many plans give the option of sharing the benefit of the Plan Participant when he/she retires, or separating the Former Spouse’s interest in the Participant’s plan so that the Former Spouse can receive his/her own pension.  The shared benefit option requires, when available, the purchase of a Post Retirement Survivor Annuity so that the Former Spouse’s benefit continues if the Participant predeceases the Former Spouse.

Things to take into account when dealing with retirement plans:

  1. Has any of the retirement been earned before the marriage?  If so, then how much of the accounts are separate non-marital property.
  2. Do we need to use retirement plan assets to balance against other assets, such as the equity in real estate?
  3. If we have pension plans and want to know the value of the plan, do not simply look at a statement that shows the employee contributions into the plan. You will need a valuation that determines the net present value of the benefit that will paid throughout the lifetime of the Participant.

Do not delay in getting your QDRO done. Ideally it should be submitted to the Court with the separation agreement so the Court can sign it when they sign off on your decree of dissolution or legal separation.  Delaying could mean that you forfeit your right to any of the retirement you thought you were going to get, or some of the options that would have been available if you would have completed it sooner.

Steve McBride
McBride QDRO Services

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