Retirement plans and the funds they contain are often one of the most valuable assets in a divorce, second only to the family home. Therefore, if you are currently facing the prospect of a divorce or dissolution of a civil partnership, any existing retirement funds you or your partner have should be a key consideration in any financial settlement.
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It’s common for one partner to have a larger retirement account than the other, especially in cases where one party has earned less or perhaps even not at all. Usually in order to be a stay-at-home parent and help manage domestic affairs. Unfortunately, these funds are often neglected in the financial settlement of a divorce, in particular by women who tend to live longer than men and therefore often require greater pension savings.
To make matters more complicated, how the money in these accounts is divided in the event of a divorce, differs depending on your state.
In this guide, I’ve detailed everything you need to consider in order to ensure you are protecting your retirement assets and what options are available when it comes to splitting them fairly.
Of course, every situation is unique, and whilst my guide can equip you with all the relevant information, it is not intended to replace the advice of a family law attorney which I would recommend in complicated circumstances or during an acrimonious split.
Step-by-step guide for splitting retirement plan in the case of divorce or dissolution
It’s A Question Of Geography
First of all, before we even start it should be noted that the law is a varied and complex beast, and depending on where you live different rules will govern the divorce process. For example, in the states of Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin any assets acquired by either spouse during the marriage are considered to be joint assets. This means that any financial resources accumulated during the marriage, such as retirement funds, are divided equally between both parties.
In all other states that follow equitable distribution rules, the courts will divide marital property in an equitable manner that is fair. This does not however necessarily mean equal, and as such 401(k) or IRA earnings accrued during the course of a marriage will not be split 50/50.
Dividing Qualified Plan Assets vs. IRAs
The type of asset in question will determine how its funds are split, as different rules apply to IRA and qualified plans. Even if your legal separation from your partner is entirely amicable and results in a 50/50 split, the assets in an IRA are divided by means of “transfer incident to divorce,” while 403(b) and qualified plans such as 401(k)s are split under a qualified domestic relations order (QDRO).
The assets and their division will need to be declared to the judge, or arbiter, and clearly delineated, in order to ensure that they are correctly listed during the separation process.
Dividing a Qualified Plan: QDRO
Divorce is one the rare times that the federal protection given to retirement plans from seizure or attachment by creditors or lawsuits is waived. Divorce and separation decrees allow the attachment of qualified-plan assets by the ex-partner of the plan account owner by means of a Qualified Domestic Relations Order (QDRO). The QDRO divides the relevant retirement plan assets between the two parties, or children, or other dependents.
This division of assets is exempt from tax, assuming that these assets have been reported correctly to the court and custodians of the retirement plan. The assets then received by the second party may be rolled into their own qualified plan or an IRA plan.
Dividing an IRA: Transfer Incident
It is important that you specify that any division of the assets in an IRA is clearly specified and stated, as this way you avoid paying tax on the separation transaction. Such a reallocation of funds may be defined as either a rollover or transfer by the IRA custodian, depending on the circumstances relating to the division and wording of the decree.
Once this transfer is completed the recipient is liable for any tax consequence of any future distributions or transactions. As such the owner of the account from which these funds were reallocated is exempt from the future tax burden of the assets transferred.
It is important that you clearly list both the division percentage and the total dollar amount of assets transferred in order to ensure any early withdrawal penalties.
What Happens If We Both have IRAs or 401(k)s
If both parties have a retirement plan in place, then assuming that one of the accounts has a higher value than the other, then a QDRO or transfer of funds would most likely be requested by the arbiter or judge.
How Do You Collect Your Share?
There is no set rule for how the assets due in a divorce are to be paid. If the other party is the “alternate payee” they can agree to a lump sum payment, or they could wait until such time as payments are due and then get their share of these benefit payments.
How To Transfer Funds
In some cases, the “alternate payee” may decide to open their own IRA account, or maybe they already have one, in which case they could request that the funds due to them are transferred to this account.
In the case of IRA accounts, this process is very easy, as established brokers such as Fidelity, Charles Schwab, and Vanguard ensure the process is easy, quick, and secure. However, I should again stress that any withdrawal from the traditional IRA — excluding the initial transfer from one spouse’s IRA to the other — will be subject to tax and early withdrawal penalties, assuming your spouse is not yet 59½ years of age.
Amicable Division Of Assets
In the case of the amicable division of assets, including those in a retirement plan, it is important that you pay attention to the details in order to ensure you minimize your costs and possible fines or taxes. The IRS is extremely keen to get its slice of the pie and will use any excuse it can to take your money.
Not crossing those t’s and dotting the i’s can make the process that much more complicated and expensive, especially if large sums of money are involved.
How To Stay on Top
A divorce can be a stressful process to help minimize the stress it is important to stay on top of things, which may be pretty daunting as is and for this reason, I recommend that you consult with a family law attorney.
Even if the separation is amicable, it is best to consult with a professional who can help you manage the complexities of splitting assets and help you safely navigate the financial situation. As I mentioned earlier failing to do the paperwork properly can result in you and your former partner being levied with extra, and completely avoidable taxes and fines.
Successfully collaborating during the separation process is the key to ensuring your own financial security in retirement. There are many moving parts in a divorce and you should consult with an expert but this guide has hopefully highlighted some key areas and given insight into the process.
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