Some things are meant to be shared, not divided. That statement is particularly true of retirement assets. 401(k)’s, IRAs and pension plans are notoriously difficult to split. Add in tax consequences and conflicting advice you might be getting from your family, neighbors, attorneys and the Internet, and you have a financial disaster in the making. Here is what you need to know to make good decisions.
1. Retirement funds added during the marriage are typically considered marital property
Retirement accounts include 401(k)’s, IRAs and retirement plans – and they often don’t get the attention they deserve. In my experience, most divorcing couples see children and the family home as main battle grounds. Those topics get much of their focus and heated debate. By the time the spouses come to consider retirement assets, their attention is spent and their energy is exhausted.
In reality, for individuals who are leaving a long marriage retirement assets can add up to a considerable amount. In some cases, they are more valuable than the family home! I advise my clients to get a financial specialist involved early to make sure retirement funds are addressed properly.
2. You will need a QDRO
A QDRO, or a Qualified Domestic Relations Order, is required to execute the split of the 401(k) accounts and most pension plans. Your divorce settlement agreement is not enough! The plan will need the QDRO document to make the payments to the correct spouse.
When it comes to QDROs, not all of them are made equal. Here more than anywhere else, words matter. The order must be spelled out in careful detail to ensure that the divorcing spouses each get exactly what they had agreed to.
Here is a good example: let’s say we have a husband and a wife going through a divorce. The husband has a 401(k) account worth $100,000 that has been accumulated during the marriage. The spouses agree that it would be fair to split the balance equally. Let’s pretend that the intention is to split the account 50/50 so the QDRO agreement states “Wife gets $50,000” instead of “Wife gets 50%.” If the market crashes, bringing the 401(k) account balance down to $50,000 any time before the agreement is signed and executed, we have a problem. In that situation, the wife will effectively get 100% of the account balance while the husband will get none of the account balance.
The QDRO must also spell out what happens in the event of an early death, especially when you are dealing with pension plans. Couples must be careful with non-qualified plans like supplemental executive retirement plans or excess benefit plans, stock options, and deferred compensation. Those are typically not subject to QDRO rules and often cannot be paid out to anyone but the employee – no matter what the order states.
3. Beware of the tax man!
Decisions have tax consequences, and I urge anyone who is going through a divorce to consult with a CPA before any agreements are signed. That is the only way you can be sure that all decisions have been considered on the “after tax” basis. For example, retirement account transfers must be executed correctly to avoid triggering a tax event.
Splitting retirement assets can be tricky.
No article can adequately address the complexities and intricacies of dividing retirement assets. Here are some best practices that should guide you to create the best outcome for your financial future.
- Make sure your legal and financial professionals spend adequate time on working out the specifics of the retirement account division. Compared with urgent issues like child custody and the fate of the family home, retirement may seem unimportant and less pressing in the moment. Please don’t be fooled into thinking that the issue will sort itself out: your financial security is on the line!
- If your attorney suggests that QDROs are simple enough (“Just fill out this form!”) be sure to seek expert advice. Retirement account division is far more complex than splitting a checking account!
- As with any financial decisions, insist on explanations and clarifications until you fully understand what is being recommended and how it will support your long-term goals. Yes, these issues are highly technical – and yet I believe that anyone is capable of grasping the basics of the proposed asset split.