Retirement Accounts in Divorce: Who Gets What?
If finances aren’t your jam and your calculator is lost somewhere in the junk drawer, you might have questions about dividing retirement accounts in divorce.
“My spouse has worked at XYZ company our entire marriage and all our retirement savings are in his name. I was a stay at home parent and don’t have my own retirement account. Does that mean I’m not entitled to any of that money?”
That is a really common question I get from clients. And some shady spouses even try to convince their partners that this is true. But let’s separate fact from fiction when it comes to retirement accounts in divorce.
Any money paid into a retirement account during the marriage is considered a marital asset no matter whose name is on the account. In some states, the interest earned on the account during marriage is marital property even if the account was from a job prior to marriage.
It is true that if the account pre-dates the marriage, then some of that money could be considered separate property. However, we can calculate the portion that is marital and subject to division – no worries there.
Why Do I Need to Know This Stuff?
Have you ever had a loved one in the hospital? Then you understand that the doctors and nurses are great at what they do, but they are super busy and they don’t know the patient (your person) as well as you do. You get the best treatment and the best outcome in the hospital if you pay close attention and advocate for your patient.
The same goes for divorce. Your attorney is awesome and a super, duper legal mind. But they have a bunch of clients and don’t know you and your life the way you do. You need to understand what you are entitled to and be involved in the decision making.
You need to be your own best advocate in divorce to get the best outcome.
Doing your due diligence to understand retirement accounts in divorce is no exception. Learn what’s on the table, what you are entitled to and how choices will impact you. You’ll make better decisions and have fewer surprises.
Defined Contribution Plans vs. Defined Benefit Plans
Retirement plans are as varied as flavors of ice cream, but they generally fall into 2 categories. It’s important to know which you are dealing with when negotiating the division of retirement accounts in divorce. 401(k) type plans and pension plans require a different approach.
Terms to Know:
Participant – this is the person who owns the account
Alternate Payee – this is the non-participant spouse that a portion of the account will be transferred to
Coverture Fraction – number of years you were married divided by number of years the asset has been held = % marital share
So, if the 401(k) plan belongs to your spouse through their employer, then they are the participant and you are the alternate payee. If they have been employed by XYZ company for 25 years and you have been married for 20 years, then the coverture fraction applied when looking at pension benefits would be .8 or 80% (20/25 = .8).
Okay, now that you know some of the terms and how they come into play, let’s dive into the two types of plans and how they are effected in divorce.
Defined Contribution Plans
These plans have a cash value today and you typically see a quarterly or annual statement showing you the balance in the account. The most common type of defined contribution plan is the 401(k). Federal employees and military have a similar plan called a Thrift Savings Plan or TSP – it just has special rules and requires special processing to divide it.
Division of these is relatively straightforward since the cash value as of date of separation (or date of divorce) can be easily determined.
The participant’s account value can be divided either equally or unequally depending on the terms of your agreement. That money then remains in separate account in the alternate payee’s name (if that is an option) or can be transferred to an IRA.
If your spouse worked at this company and had a balance prior to your marriage, enlist the services of a CDFA® or other financial professional to determine the marital amount that is to be divided.
It is important to understand and execute the proper method to pay a portion of the plan to an alternate payee. Some plans (like 401k’s) require a Qualified Domestic Relations Order or QDRO and others (like IRA’s) only require a copy of the final judgement of divorce.
Defined Benefit Plans
A traditional pension promises an employee a future monthly payment amount based on some formula usually including years of service, age and salary. It does not have any cash value today.
We can, however, value this future stream of income and calculate the present value. This allows us to include it as an asset for the purposes of dividing the marital property.
You will want to understand all your options for receiving a share of your spouse’s pension plan. Most common is either a lump sum payout in the settlement agreement based on the calculation above or a fixed or % share of the pension payment once the employee retires.
Because pension payments could stop when your ex-spouse dies, ask about survivor benefits if you take the payment option (or separate life insurance on your ex) so you aren’t left without income.
Each plan has different rules about how they are divided and when you can access benefits as a non-payee spouse. So, check with your attorney to ensure that accepted language is included in your agreement.
Takeaways:
1. Your spouse’s pension and retirement accounts are marital assets and should absolutely be on the table for discussion and negotiation.
2. Choose an experienced family law attorney to ensure that the plans are divided properly and on a timely basis.
Tax Implications of Dividing Retirement Accounts in Divorce
So, you’re negotiating your settlement and everything seems cool. After all, a dollar is a dollar, right? You’re getting $100,000 from your spouse’s 401(k) and they are taking the $100,000 stock account.
Not quite yet. There are some cagey rules around taxes when it comes to splitting up retirement accounts in divorce. That $100,000 may only be worth $70,000 to you if you are counting on using it now.
Here is the high level overview:
1. If you roll your distribution directly over to an IRA in your name → no taxes or penalties will be assessed.
2. If you take a direct distribution (payment to you) → a 20% tax may be withheld.
3. If you take direct distribution and are under 59½ → the 20% tax will be withheld and you may pay a 10% early withdrawal penalty.
4. You have a one-time opportunity to avoid the early withdrawal penalty if you make that election at initial distribution. Once the funds are transferred to an IRA or other retirement account, penalties for early withdrawals will apply.
Did You Almost Fail High School Algebra and You’re Shaking Just Reading This?
If all this lingo about dividing retirement accounts in divorce sounds confusing to you, you’re in good company. Many of my clients haven’t been solely responsible for a household’s finances, so this is all new. Here are a couple of other posts that might help:
Getting sound financial advice is critical to understanding exactly what you are agreeing to in your settlement. A Certified Divorce Financial Analyst® has special training in the financial aspects of divorce and can help you analyze both the short-term and long-term impact of any proposed settlement offer.
You only have once chance to get this right. Be sure today’s decisions don’t leave you out in the cold tomorrow.
Help is Here
In addition to my financial background and experience as a CDC Certified Divorce Coach®, I went on to complete my training as a Certified Divorce Financial Analyst® because I understand how important financial decisions are in divorce.
Schedule a FREE, 30-minute Discovery Call and let’s chat about how you and your calculator are getting along. Maybe I can help. Just click the button below to get direct access to my calendar.
Wishing you strength and wisdom,
