In most all divorces, retirement accounts, along with a family home, will be the largest assets that will need to be divided.
Understanding how they are split up and the rules that apply in various circumstances are important pieces of information that will allow you to move forward with a higher degree of confidence and knowledge at a time when you most need it.
How are Retirement Accounts Handled in Divorce?
Retirement accounts are treated as marital (or community) assets in divorce and must be divided in an appropriate way as part of the settlement process.
On the surface, this sounds simple enough, but there are several rules, laws and procedures that must be followed so that the division is done properly.
Some of the important elements that impact how funds are divided include when the asset started to accrue, what type of retirement asset it is, and what the marital cut-off date is so that a proper value on the account can be established.
There are two types of retirement accounts:
A defined contribution plan is also referred to as a savings plan.
These types of retirement accounts are characterized by the employee, the employer, or both making contributions to a retirement account in the name of the employee.
The most common of these is a 401(k) plan, although other defined contribution plans include 403(b), 457(b), IRA, Profit Sharing Plan, etc.
A defined benefit plan is a company retirement plan, such as a pension, that pays a benefit that is based on an employee’s years of service to a company and their salary history.
Defined benefit plans start paying monthly benefits when an employee retires. Those payments will continue for the rest of the employee’s life and may include survivor benefits.
To divide a retirement asset, the first thing that should happen is that a value must be placed on the asset.
There are various methods for doing this, partly governed by what kind of asset it is (defined contribution plan or defined benefit plan) and what the laws are in a particular state regarding valuation.
Once valuation has been decided, a judge will be able to use that amount in determining an appropriate amount that each spouse should receive.
In community property states, that split will be 50/50.
In equitable distribution states, the amount may vary based on a number of factors.
In addition, it may be possible to negotiate a different split than 50/50 by trading the value in one asset for another. For example, one spouse may want to own the family home after a divorce and if that’s the case, he or she may be willing to give up a greater share of any retirement assets.
Once a final divorce decree has been issued spelling out the terms of how retirement assets should be split, in most cases a Qualified Domestic Relations Order (QDRO) will need to be executed.
This is a court order judgment that is presented to a retirement administrator directing them to split an asset into two accounts.
QDROs only cover plans that are IRS tax-qualified and covered by the Employee Retirement Income Security Act (ERISA).
They do not apply to government pensions or military pensions (although separate Domestic Relations Orders referred to as a “COAP” are required), and you also do not need a QDRO to separate Individual Retirement Accounts (IRAs).
IRAs are governed by Internal Revenue Code section 408. In order for the transfer of an IRA from one spouse to the other to be nontaxable, the transfer must be made pursuant to a divorce or separation instrument.
After the QDRO is accepted by the plan, the defined contribution plan asset is separated into two accounts and the funds are delivered to the other party according to their directions.
A defined benefit plan will establish a separate interest on behalf of the former spouse and pay a lifetime benefit to each party.
Who Handles Dividing the Retirement Plans?
There are many parties who will play a role in dividing retirement plan assets.
When a retirement asset is identified as part of a divorce, your spouse is required by law to identify it as an asset on a financial disclosure statement.
If you are working with an attorney, they will make sure this is included, but if not, you must make sure you include this asset in any disclosures as well.
Once an asset has been identified, attorneys may negotiate how it will be split as part of attempting to reach a settlement between parties.
If no agreement can be reached, then that job will fall to a judge who will review the information, determine how it fits into an overall asset distribution plan and make a legal and binding decision.
Once the divorce decree has been finalized, part of the court order will include directing account custodians to separate the funds according to a decree.
In some cases, this will require the execution of a QDRO which can be created by an attorney or other qualified professional.
When a QDRO is not required, a divorce decree can be presented to an account custodian, such as a bank or a financial services company, who will then separate the funds according to the order put forth in the decree.
What are the Different Methods for Dividing Retirement Accounts?
Before you can divide a retirement account, you need to know how much it is worth.
For a defined contribution plan, this is relatively easy. It is usually the amount of money in an account at a certain date.
For a defined benefit plan, the monthly benefit is typically based on a formula that incorporates your salary and years of service.
Determining the value of a pension in divorce is much more complicated and may require retaining an expert to determine the actuarial present value of the benefit.
Once the value has been determined, there are two methods that are employed to divide an account.
The Immediate Offset Method takes the actuarial present value of the retirement account and compares it to other marital assets.
If a retirement account is fairly sizable, it may be compared to the net value of the family home, for example.
Depending on the financial goals of each spouse, the spouse who earned the retirement account can retain the rights to it, while the other spouse is given a larger share of the marital asset in question in exchange for giving up interest in the retirement account.
In other words, the amount of the retirement account asset is offset against the amount of value in the house, or other marital asset.
The Deferred Distribution Method is the other way that a retirement account is divided.
In this instance, the benefits are not divided until they are payable under the retirement plan at a future date.
Terms of the payout are determined by the execution of a (Q)DRO which determines how much each spouse will receive when the benefits become payable.
The portion of a retirement account to be divided only includes those proceeds that were deposited, or accrued, during a marriage.
If a retirement account was in existence before a marriage, or funds were deposited after spouses separated, then those amounts are generally considered separate property and will remain with the employee/contributory spouse.
One exception would be a Profit Sharing Plan in which an employer contribution is made after the date of separation but is attributable to employment prior to the date of separation.
When is the Value of the Retirement Accounts Determined?
The value of retirement accounts can vary by state, but a good rule of thumb is that any funds added to a retirement account during a marriage will be considered marital property.
Any earnings generated during that time are also considered marital assets as well, and subject to distribution based on the laws of the state where you are getting a divorce.
The point in time when a retirement account is assigned a dollar amount is known as the valuation date.
However, if you entered a marriage and you already had funds in a retirement account, then those funds will generally be treated a separate property in most cases.
They will not be subject to equitable distribution or community property laws, but the burden of proof establishing such pre-marital separate property lies solely with the party making such claim.
The date of separation is generally considered the cut-off date for when funds are considered marital property, but the valuation date can also be the date of a divorce trial, or the date a divorce complaint was filed.
This means any funds you contribute after your date of separation may be considered as separate and not subject to being labeled as a marital asset or to be divided among both spouses.
Again, the rules here vary by state, so it is best to check with an attorney to make sure of how this works in your state.
How is a 401K Divided During a Divorce?
Although a divorce decree can stipulate that retirement funds must be divided, when a 401(k) is involved, the only official way to separate the funds is by executing a Qualified Domestic Relations Order (QDRO).
As you are going through the divorce process, it is essential that you identify retirement assets so that they can be properly addressed in the divorce decree.
The divorce decree must order the division of all affected retirement accounts and detail which spouse receives what as part of the court order.
To execute the separation of the 401(k) plan, a QDRO must be drafted that will tell the 401(k) plan administrator how to divide the retirement asset.
It’s strongly recommended to submit the draft QDRO to the 401(k) plan administer for their review and approval.
Once you have ensured that the QDRO meets the requirements of the 401(k) plan administrator, you must then submit the QDRO to the court for their approval.
The endorsed-filed copy of the QDRO can then be resubmitted to the plan administrator to effectuate the transfer.
The QDRO establishes an alternate payee who will now also be able to receive payments from a 401(k).
Each retirement account will require a separate QDRO (although on occasion you can combined orders if retirement plans sponsored by the same employer), so if you have multiple retirement accounts, be prepared for this eventuality.
The alternate payee can take their portion of the proceeds and put it into his or her own retirement account, leave their share intact in the existing plan, taking payments when the participant is eligible to retire, or can take the proceeds in a lump sum cash payment.
If a spouse takes a lump sum payment, the IRS will treat that as ordinary income and there will be a tax liability on the amount (early withdrawal penalty waived on distribution to an alternate payee pursuant to a QDRO, see IRC 72(t)(2)).
How is an IRA Split in a Divorce?
A QDRO is not required to divide the assets in a traditional or Roth IRA, but you must still make sure the split is done pursuant to a court order (such as a Divorce Decree) such that you do not have to pay penalties or taxes.
Your divorce decree must specify that the IRA will be split, including dollar amounts or percentages and the time frame in which it must be completed.
The custodian of the IRA, which is generally a bank, a brokerage or a financial services company, will need a copy of the divorce decree, along with appropriate paperwork to initiate the split.
In anticipation of the split, a destination IRA should already be in place so that the funds can roll over into it.
When an IRA is split between spouses and not done as a trustee-to-trustee transfer, then it is generally considered a taxable event for the IRA’s original owner. (You should know that there is a 60-day rollover exception. In essence, this enables you to rollover the IRA funds by taking a distribution and then depositing the funds back into the IRA within 60 days. Nevertheless, the best course of action is to divide an IRA as a trustee-to-trustee transfer.)
This means they would not only pay income taxes on the distribution, but also a 10% early withdrawal fee if they are under 59 ½ years old. There may also be early withdrawal fees at the State level. For instance, in California, the early withdrawal fee is 2.5%. Roth IRAs are treated differently because contributions have already been taxed, but the Roth owner could still face tax or withdrawal penalties depending on their age and how long they have owned the Roth IRA.
Pension plans are separated using a QDRO (Qualified Domestic Relations Order), but IRAs are separated in a process known as a “transfer incident to divorce” (see IRC 408(d)(6)).
Each has its own rules that must be followed, and this is why it is important to designate which category your retirement account falls under when submitting your information to the courts. If done incorrectly, it can produce significant delays.
When an IRA division is reported as a transfer incident to divorce in a final decree, no tax is assessed when the funds are separated, as long as the funds are classified as either a transfer or a rollover by the IRA custodian.
Once the transfer is complete, the recipient is responsible for paying taxes on any future distributions or withdrawals on their own. If you do not label the division properly, then you could be on the hook for future taxes and an early withdrawal penalty as well.
It is important to note the exemption to the early withdrawal penalty under IRC 72(t)(2) does NOT apply to a former spouse in an IRA transfer order.
The instructions you provide must be approved by both the sending and receiving IRA custodians, as well as the judge and state laws.
If the agreement is not approved by the courts, you will be required to file an amended tax return that reports the entire amount you sent to your ex-spouse as ordinary income, and you will be taxed accordingly.
What is QDRO?
A QDRO is short for a Qualified Domestic Relations Order.
It is a court order or a judgment that instructs your spouse’s pension plan to pay you a share of the plan’s benefits.
It gives you the added protection and benefits above and beyond a divorce decree because it specifically addresses funds in a retirement account that must be separated and withdrawn without penalty and deposited into the other non-employee spouse’s retirement vehicle or other type of payout.
The person who earned (accrued) the benefit is called the “participant” while the person who is granted a portion of the retirement account through a QDRO is called the “alternate payee.”
In some cases, a QDRO may be known by other names, such as when dealing with retirement plans for a federal government employee.
In these instances, they are known as COAPs, or Court Order Acceptable for Processing.
QDROs apply only to plans that are IRS tax-qualified and covered by ERISA (Employee Retirement Income Security Act) provisions. You do not need a QDRO to divide IRA assets, but you will need your Divorce Decree.
With respect to a SEP-IRA, some attorneys believe a QDRO may still be required as this type of account is associated with employer-provided benefits and subject to ERISA (thus requiring a QDRO to divide).
It is important to note that federal laws state that a retirement benefit can be divided between former spouses only when a QDRO is put in place.
A divorce decree by itself typically does not rise to the level of a QDRO, even if the decree states that retirement funds are to be divided. The QDRO is a separate document that will need to be executed on its own.
Although a QDRO can be executed at any time following a divorce, most experts agree that it is advisable to obtain the QDRO and file it with a retirement plan as soon as possible.
If a participant retires after a divorce and no QDRO is in place, they can begin collecting benefits on their own and the terms of the QDRO will only impact future payments after the QDRO has been filed and accepted.
If a participant has already commenced receiving benefits prior to entering the QDRO, you will not be able to change the form of payment elected by participant (meaning there may be no survivor benefits payable upon participant’s death).
In addition, if a divorce decree does not address retirement benefits, then the former spouse will have no rights by using the divorce decree to obtain a QDRO.
The only way to obtain a QDRO in this instance would be to reopen the divorce proceeding, which could be costly and take several years to resolve.
QDROs are tax-free transactions as long as they have been recorded properly with the courts and with IRA custodians.
The alternate payee can rollover QDRO assets into their own retirement plan or into a traditional IRA without taxation or penalty. If an alternate payee wishes to rollover their award into a Roth IRA it will be taxed as a conversion, but it will not be penalized.
Any transfer from a qualified plan in a divorce settlement that is not considered a QDRO by the IRS will be subject to taxes and penalties.
How do I get QDRO Papers?
If you are already working with an attorney as part of your divorce, make sure they know that a retirement plan asset is part of the divorce action and that a QDRO will be required.
If you are not working with an attorney, you can contact an attorney or other professional who specializes in QDRO preparation or find a qualified legal expert through the National Pension Lawyers Network.
As part of your divorce, you will need to notify the court that a retirement benefit is part of the divorce action.
This will compel the court to require that your spouse provides all the necessary information the court needs to divide the retirement benefit. This also applies to any pension plan information that you may need to provide if your pension is to be split as well.
Each retirement plan will have its own rules for what information must be required in a QDRO and a separate QDRO may be required for each plan. At a minimum, all QDROs must include:
- The name and mailing address of the participant and alternate payee
- The name of the plan to which the QDRO applies
- The dollar amount or percentage of the benefit that must be paid to the alternate payee
- The number of payments or time period that applies to the QDRO
Once the QDRO has been prepared by your legal representative, you need to submit it to the plan as soon as possible.
The plan will acknowledge receipt and whether it has accepted the QDRO or not. If it has been accepted, no further actions will be necessary on your part.
If it is rejected, you will be given an explanation for the rejection and what steps you must take to ensure that the QDRO is accepted by the plan.
Am I Entitled to any of my Ex’s Pension?
It depends on a number of factors, many of them having to do with the state in which you’re getting divorced.
If you live in an equitable distribution state, then a judge will divide marital assets in a way that is considered equitable, but not always on a 50/50 basis.
Pensions are usually one of the biggest assets that a divorcing couple has, so an equitable distribution most always takes a pension into account.
In a community property state, all marital assets are divided equally, meaning each spouse is entitled to half of each community asset. You will be entitled to 50% of the community property interest of your spouse’s pension and they will be entitled to 50% of the community property interest in yours.
Although you may be entitled to your spouse’s pension, often times spouses negotiate a settlement that trades the value in one asset against the value of another.
For example, to keep full possession of a family home, a spouse may give up a greater portion or possibly all of their interests in a pension.
This give and take means that a distribution will still be done in a fair manner, but you may not wind up with any of your ex’s pension depending on what agreement you can reach.
One other thing to keep in mind is that retirement funds accumulated before a marriage are most likely considered as separate assets from a marriage and not entitled to be considered as part of a split. You should discuss this with an attorney just to be sure, depending on the rules in your state.
Can I Change the Division of my Retirement Account After the Divorce?
You must follow what is specified in a divorce decree.
If you have a 401(k), then the details of how a retirement account must be handled will be specified in a QDRO.
If you have an IRA or a SEP, then the division of that asset must follow the terms specified in the decree.
If you make any material changes in a retirement account either before, during or after a divorce that go against what is specified in legal documents or as otherwise required by statute, you could be setting yourself up for legal battles that you may have a hard time winning.
When in doubt, consult an attorney or Certified Divorce Financial Analyst about the right steps to take.
How Will the Pension be Affected if my Ex Remarries?
If the retirement account is payment for alimony or child support, then any QDRO payments will typically end, just as they would end if the QDRO provides for child support and a child emancipates and leaves home, no longer requiring financial support.
If any portion of the retirement benefits relate to marital asset division, this part will remain intact regardless of marital status (although sometimes survivor benefits may be affected).
How Can I Prevent My Ex from Taking Money out of the Retirement Accounts?
If you are concerned that your spouse might take funds out of a retirement account during a divorce, then you can contact the plan’s sponsor to see if they will flag the account and notify you if that happens.
You should consult with a legal professional about filing a “Joinder” or issuing a “Notice of Adverse Interest” to freeze the participant’s account pending execution of a QDRO. In most cases, plans will allow for this. In other cases, such as federal or military retirement plans, they will not.
Any funds and appreciation accumulated during a marriage in a retirement account are considered marital property.
If a spouse withdraws funds prior to a divorce, then those funds must be properly accounted for and reported as part of the financial disclosure process. Those funds must be accounted for so that a division of assets can take place in an appropriate manner. The exception to this is if the funds were used to the benefit of both spouses.
Spouses who attempt to hide the withdrawal of assets from a retirement account could face civil and possible criminal charges.
In addition, the courts may levy some form of punishment as well by awarding the other spouse a larger share of proceeds.
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