How Retirement Accounts Are Divided During Divorce

Going through a divorce is something that nearly half of all married couples will experience in America. The divorce process is unfortunately as natural as the marriage process itself at this point. As parties navigate the divorce proceedings, money is always an issue. You can be met with quite a few financial challenges, especially if you’re the party with more money in the relationship. Perhaps the most complex divorce challenge, in the context of finances, is the retirement account. Whether a 401(k), an Individual Retirement Account (IRA), a pension, or any other type, the thought of losing this can be overwhelming.

It’s important to understand the rules, procedures, and legal mechanisms involved in protecting your long-term financial security. How much an ex-partner will be entitled to via your retirement account depends on myriad factors. Step one in any process here is to retain a qualified divorce lawyer like the attorneys at Davis & Associates.

Understanding Different Types of Retirement Accounts

It’s important to understand the different types of retirement accounts that you may have. Retirement accounts generally fall into two main categories: defined benefit plans and defined contribution plans.

A defined contribution plan is your typical 401(k), or perhaps a 403(b). These are the bulk of most private-sector thrift saving plans. Accumulated through regular contributions, these funds are held until the point at which the owner accesses them. While you do not have to wait until retirement, most fiscally responsible parties do allow their accounts to accrue until the point at which they retire. In most jurisdictions, any contributions made, either by the owner or employer, are considered marital property if they were made during the marriage.

This is likely not what divorcing parties want to hear, but it is the law of the land in most states. Therefore, these assets are subject to joint distribution. Any contributions made prior to the marriage are not spousal property. To separate the contributions, a forensic accounting is likely needed.

With a traditional pension, which falls into a defined benefit plan, this is a bit more complex to navigate. Rather than contributions made, payout depends on other factors. The years of service you put in, the contract, salary history, retirement age, and other factors dictate how large the pension is and how it will be paid out. This account will also be considered marital property during a divorce. It is looked at as an asset, and all assets must be divided per a divorce agreement. Even if the pension is not being paid out yet, it will still be part of divorce negotiations.

IRA accounts are also subject to division. The biggest difference here is that funds can be transferred voluntarily and do not require a court order. A direct transfer can be executed in a tax-free manner. However, the court can certainly still order an unwilling ex-spouse to make a transfer. The long and short of it is that if you made any money during marriage, it’s considered spousal property, not personal property.

The Mechanism of Division: Qualified Domestic Relations Orders (QDROs)

Any employer-sponsored retirement plan is governed by federal law via the Employee Retirement Income Security Act (ERISA). You are not allowed to simply withdraw funds or change account ownership with these accounts. You need specific legal documentation. So your 401(k) account, for instance, cannot be accessed to give over funds without incurring harsh tax penalties outside of government oversight. You must obtain a QDRO document. This is a separate court order that instructs the plan administrator to deliver the funds to your ex-spouse.

A QDRO is a complex document that must be crafted with precision. If and when the settlement decrees that one spouse must pay another, an accurate document is needed before funds can be transferred. The QDRO must also be approved by the domestic relations court (family court) and the plan administrator. Consulting with a qualified divorce lawyer for this type of documentation is highly encouraged.

Valuation, Tax Implications, and Long-Term Planning

Whether or not this is “fair” to the account holder, this is still the law. With the help of a good attorney, you may possibly reach an equitable settlement that doesn’t require the stereotypical “split it down the middle” outcome that’s so widely portrayed in public media. How your accounts can be taxed by the government also plays an important role here. In a traditional 401(k), withdrawals are taxed as ordinary income. In a Roth IRA, withdrawals can be tax-free. This is vital when concluding how much an ex-spouse is entitled to.

It’s also important for couples to decide whether to offset their assets against other marital property. A good example here is when a spouse may choose to allow one party to retain full ownership of a retirement account in exchange for other equity in marital property. In other words, if one party gets the house, they may not pursue the accounts. This, of course, is dependent entirely upon both parties negotiating.

This is a process that will require a lot of patience on anyone’s part. These issues of accounts and ownership are not typically settled in a single meeting. Lawyers work to arrange a fair and equitable split. What you need to do in this situation is ensure that all of your documentation and records are lined up.

Weighing the Options

Marital property extending to one’s IRA or their pension is something a lot of divorcees do not realize is legal. It is important to understand that these accounts are in fact going to be shared. Against your consent or wishes, a court may find that your ex-spouse is entitled to up to half, or even more, of your account. Weighing your options in a divorce is crucial. For instance, if your spouse will take something in exchange for allowing you to keep your pension, this may be a more favorable outcome.

We start getting into territory that only a divorcing couple can understand when talking about negotiations. Just know that, factually and legally, you are required to share whatever your retirement accounts accrued during the period of marriage. Whether this is fair or right, that’s a topic for another time. Understand that your ex-spouse can legally take their share of any retirement account.