Spouses going through divorce who saved for retirement throughout their marriage face obstacles when faced with property division. Like many financial assets, the value of many retirement instruments fluctuates with market conditions or changes with tax regulations. Often, the amount of equity in an asset reflects only a snapshot of its value. This can complicate matters when it comes time to split assets equitably in a divorce.
A few of the major vehicles used to save for retirement include pensions, 401(k) accounts, and individual retirement accounts (IRAs). All of these financial tools are subject to taxes, either at the time they are funded or when the benefits are disbursed. For example, funds financed with pre-tax dollars will have taxes applied when the money is taken out during retirement. Therefore, during negotiations to split up marital assets, the values of these retirement accounts should incorporate the ultimate tax bill.
However, before any retirement assets can be divided, certain grounds for division have to be established. In some cases, such division may be based simply on a divorce decree to establish the conditions for the transfer. Others require a separate court order known as a qualified domestic relations order (QDRO) to serve as the foundation for how the divisions should proceed.
Neglecting to obtain a QDRO order will affect the conditions under which retirement assets are divided. If the divisions are not appropriately labeled, the transfer will likely incur undesirable early withdrawal and tax penalties on the funds transferred between certain types of retirement vehicles. An unqualified transfer from a retirement account may prevent funds from being suitable for rollover or other intended transfer into a former spouse’s retirement portfolio.
Understanding the particular effects of any given transfer will require a thorough review of the plan’s specific policies and the corresponding legal regulations. However, a brief overview of the three major types of retirement devices can be useful. Below is an explanation of how pensions, 401(k) plans, and IRAs differ and how they are treated when dividing assets in divorce.
A long-standing retirement funding tool is an employer pension plan. These plans are offered to employees as a benefit to support them in retirement. Retirement support from pensions is usually paid incrementally, such as monthly or annually, once the employee retires.
Pensions are typically considered a joint asset. Upon retirement, pension payments can be made directly to the employee’s former spouse. These spousal benefits may be made until the employee’s death but often extend beyond the employee’s lifetime.
In divorce, the employee may wish to consider speaking with their lawyer or a certified financial planner in order to assess the division of this type of asset with regards to tax obligations and other rules. Different states have different laws to abide by regarding the division of pensions, and each individual plan adheres to its own assortment of rules. A defined pension benefit plan will require a QDRO to guide the division of assets.
Qualified retirement plans, such as 401(k) and profit sharing accounts, are financial plans offered by employers as an employee benefit to entice and retain personnel. These plans meet the requirements put forth by the Internal Revenue Service (IRS) and offer tax benefits for retirement saving. Each of these plans are run by fund managers or other financial entities on behalf of the employer. These plans are subject to the individual stipulations set in the investment contract.
When it comes to 401(k) plans in particular, the funds that are held in the plan are considered a joint asset. This means that in divorce, the employee’s spouse has a legal claim to the 401(k) benefit.
Since conditions and rules differ significantly among these plans, it is wise to become familiar with the plan’s specifics before agreeing to a division of its assets. Plans can be divided by percentage of earnings or by shares, for example. Some plans allow the distribution to be allocated at the time of divorce, while others will not be dispersed until retirement.
When considering ways to divide up a 401(k) retirement account, there are four major approaches:
- The first spouse may keep the 401(k) while trading off an asset of equal value.
- The 401(k) can be divided between the two spouses.
- The fund can be liquidated or partially liquidated to pay off one spouse.
- The 401(k) can be rolled into an IRA.
Each option has its complications, legal qualifications, and tax implications. For example, liquidating the plan may have significant tax penalties and require legal authorization. Employment and/or age requirements must be met in order to roll the plan into an IRA. Division of a 401(k) plan also requires a QDRO to execute.
IRAs, whether Roth IRAs or traditional IRAs, are considered joint property if the account was opened during the marriage. If the account was open before the marriage, only contributions made with joint marital funds may fall into that category. IRAs established as part of an inheritance may remain separate from marital property, as long as it is never combined with marital assets.
Since Roth IRAs will be tax-free at the time of disbursement, their values should be considered with this tax status in mind during negotiations. Unlike pensions and 401(k) plans, division of an IRA does not require a QDRO. A divorce decree is sufficient.
Towson Divorce Lawyers at Huesman, Jones & Miles, LLC Protect Clients’ Financial Interests in Divorce Proceedings
Many couples set aside significant resources during their marriage to support their retirement years. When a couple divorces, splitting up those assets can be complicated. If you are facing a fight over the division of retirement assets in a divorce, the Towson divorce lawyers at Huesman, Jones & Miles, LLC can help. Contact us online or call us at 443-589-0150 for a free consultation today. Located in Hunt Valley and Towson, Maryland, we serve clients throughout Baltimore, Baltimore County, Bel Air, Bentley Springs, Columbia, Freeland, Hereford, Hampton, Westminster, Essex, Monkton, Sparks Glencoe, Parkton, Phoenix, Pikesville, White Hall, Carroll County, Harford County, and Howard County.