HOW IS RETIREMENT DIVIDED DURING DIVORCE?
What happens to my retirement plan?
Division of Retirement Plans accounts for one part of the division of all other marital property. The most obvious, and important, difference about retirement plans revolves around tax. These plans fall into the pre-tax category while most other assets count as post-tax. How to best represent you in their division requires a lot of math and attention to detail.
Why are they so tricky?
Division of some types of Retirement Plans can be easier than others. Each type demands a great deal of calculation and attention to detail. You should not travel this road without the guidance of an experienced attorney.
Often the simplest step determines if part of a Retirement Plan is marital property and therefore eligible for division. From there, a lot of math comes in to play to determine how an account may be divided.
How are Retirement Accounts valued?
The law considers all of the money in a Retirement Account opened during marriage as marital. Therefore this money divides equally between the parties.
However, questions arise when a case isn’t quite so simple. What happens when one spouse already has a Retirement Account at the time of marriage? How exactly do you come up with how much of that fund is, by definition, marital?
The answer to that question can be very complicated based on the facts. You need to collect as many old statements as possible, contact the Retirement Plan, etc.
You can also use a Coverture Fraction to determine what is marital and what is separate. The Coverture Fraction aids attorneys and the Court in determining that very answer. First, you divide the time the spouse both worked and contributed to the fund by the total time the spouse has had that plan. Second, you multiply that number by the value of the account.
That doesn’t seem hard?
You may think to yourself, “I could do that equation in my sleep!” Unfortunately, many more details exist that demand consideration. Retirement Plans come in various types with diverse stipulations; and we cannot forget the IRS. Tax laws vary, based on the plan and the method of distribution.
Are Retirement Plan divisions taxable?
No. Most of the time. Simple distributions between former spouses at the time of separation/divorce happen tax-free (as long as you complete them correctly). In order to fall into the tax-free category, any distribution must be specifically related to the termination of the marriage.
So far, so good. However, as we’ve already seen, not all plans are simple. Even with a standard 401(k), simply withdrawing the appropriate amount to transfer it creates a huge tax issue. To divide funds in a tax-free manner, you must understand the laws and all the options of distribution
How are defined benefit plans valued?
For this specific type of account, the rate of the employee’s salary during the final years of work provides the basis for the payout. That can be a challenging amount to determine, especially when the divorcing couple is still young. The Court does have a five-step process in place to determine a value, though.
- Determine the earliest possible retirement date;
- Establish the life expectancy at separation to ascertain how much time the employee-spouse would receive the benefits;
- Calculate the value of the Defined Benefit Plan at the earliest time the spouse could retire;
- Once the future value has been determined, discount that value to the separation date; and
- Calculate any potential contingencies and further discount the value
Clearly, much of the work involved with this process requires you to hire an expert to give his or her opinion.
What about IRAs?
IRA transfers can be quite simple…as long as they are handled properly. If they are not, huge tax penalties may result.
Some tips to remember:
- IRA funds should be transferred directly to the spouse, not withdrawn and then paid;
- If the spouse who gets a portion of the IRA does not already have an IRA account set up, he or she will need to do so; and
- Funds transferred into a non-IRA account may be taxed.
How do you divide a 401k?
In order to distribute money from a 401k, you must complete and file the Qualified Domestic Relations Order (QDRO). This legal document allows one spouse to transfer funds from a 401k to an IRA account in the other spouse’s name. No tax penalty occurs as long as the funds go directly into another retirement account. The necessary steps to handle these situations include:
- Completed and filed QDRO;
- Signed by a Judge; and
- Instructions to the Plan’s administrator on how to dispersing the funds.
Repercussions of not following these legal steps include:
- A higher tax bracket for the spouse withdrawing the funds;
- Surtaxes on other investments; and
- Loss of potential eligible exemptions.
To obtain a QDRO does not happen immediately. It takes extra time and increased legal fees. Usually, the spouse receiving the funds will pay these extra legal fees to his or her lawyer who handles all the paperwork.
Some spouses elect to receive another compensation comparable to the funds instead to avoid additional legal fees. This can come from other monetary accounts or in the form of additional marital assets.
If a spouse was married to a member of the military for at least 10 years and the military-spouse spent at least 10 of those years in service, he or she falls into the “10/10 requirement” and receives benefits directly from the Defense Finance and Accounting Service (DFAS).
The spouse may still receive the benefits of the retirement plan even without meeting that “10/10 requirement,” but he or she will not receive the payment directly from the DFAS.
For this type of fund, the distribution may be set forth in a court order such as a divorce decree or separation agreement. The former spouse will have to submit an application in adherence to the Uniformed Services Former Spouses Protection Act (USFSPA) guidelines. The spouse will need the following items:
- A completed application;
- A copy of the court order certified by the clerk of court; and
- A completed DD Form 2293.
How do you divide government plans?
Federal government plans do not adhere to Employee Retirement Income Security Act (ERISA) laws. While they do not require a QDRO, each type follows a different set of guidelines and terminology. The most common plans include the Civil-Service Retirement System (CSRS), the Federal Employees Retirement System (FERS), and the Thrift Savings Plan (TSP). For more information on the CSRS and FERS, visit https://www.opm.gov/; and for more details on the TSP, visit https://www.tsp.gov/index.html.
What about other “non-qualified” plans?
These specialized plans also do not adhere to ERISA guidelines. As a result, they can rarely be divided or transferred to a spouse, not even with a QDRO. These types of plans usually belong to high-ranking or very highly paid employees.
The spouse may receive the appropriate amount through other divisible and comparable means or through an agreement which will transfer payment in the future, typically at the employee-spouse’s retirement. However, issues can arise with taxation of such payments and with calculation of the appropriate amount.
A spouse wishing to receive the appropriate portion of such a fund must express that desire prior to the divorce settlement.
Any final tips?
A divorce decree and transfer of funds to a former spouse does not remove that spouse as a beneficiary on Retirement Plans or a Final Will and Testament. This change is typically simple to make to any plan. If you aren’t sure what to do then ask someone to help you.
What should I do now?
As we have examined, Retirement Plan Distribution can be a complex beast to handle. Do not approach it on your own. We are here to help. Contact us today to setup a consultation, or click here to schedule a consultation online!