Dividing Your Retirement Plan in Divorce
Traditionally, the first part of every year is very busy for divorce filings. There is no added legal benefit to filing this time of year, though many observers think it is most popular because the Christmas holidays have caused an imminent filing to be pushed off.
Of course, 2013 might even tip the scales more than usual because of the uncertain economy. Because of this and the decline of the real estate market over the years the retirement plan has taken the spot from the family home as the largest single marital asset for division in the event of dissolution of marriage.
A basic understanding of some of the rules and requirements for working through division of this valuable asset can be very useful. Here are some tips to help you understand some details of division with your soon to be ex-spouse.
Dividing retirement plans. The share of your retirement plan earned during your marriage can be categorized as a martial asset. As an illustration, if you worked for 20 years at a company, participated in the company retirement plan all the while, and were married for 10 of those years, at least ½ of the value of your plan would be considered a marital asset and up for division. When divided, the non-plan-participant spouse could receive a share of the benefit at retirement or could negotiate the present value of the future benefit of the plan and offset this value against other marital property. These types of plans include 401(k), 403(b), pension plans, IRA plans, and more.
401(k), 403(b) and pension plans. Dividing an employee-sponsored retirement plan like these requires a Qualified Domestic Relations Order (QDRO) from a court and the approval of the plan sponsor. The plan sponsor is the organization (usually a company or employer), that sets up the retirement plan for the benefit of the organization’s employees and has responsibility for overseeing and managing the plan.
The plan sponsor will have strict rules about divisions of their plan (as each plan sponsor is different) in divorce, and will have the final approval in how the agreement is drafted.
For example, a plan sponsor may stipulate that once the QDRO is finalized, neither party can receive plan benefits until the plan participant is of retirement age. They may have specific rules about how benefits will be paid the non-plan-participant under a variety of circumstances. They may have specific rules for how and when benefits are paid out if the plan participant is fired, laid off, disabled or dies prematurely.
Once both the plan sponsor and the court approve the proposed division of the plan, the domestic relations order becomes “qualified”. The sponsor can show you a sample QDRO for your review and is accessible to answer questions and clarify thoughts.
A QDRO then, is the legal document, approved both by the plan sponsor and then by the court, and is the primary vehicle that will be used to provide survivorship benefits to a non plan-participant former spouse. It divides the retirement benefits of a work related retirement plan, or as a vehicle for property settlement, it could be used to provide early retirement benefits independently of the participant, or could compel child support or alimony. It could be used for a distribution from a retirement plan and the proceeds could be used for purposes like debt reduction or a down payment on a house or even attorney fees.
As an important practice tip, consider negotiating any retirement plan using percentages instead of dollar amounts. This protects your interests against market volatility and the constantly changing account value of what you are trying to divide. If the underlying plan investments lose value (or gain value) between the time the divorce is filed and the day the account is divided one spouse may be awarded more than the other.
Using percentages insures the spirit of the divorce decree remains intact and avoids the inequity of having one spouse owe the other more than was intended. Also, consider the fact that if you are negotiating for a pension plan the future value of that plan my change due to circumstances. Things like cost of living adjustments, vestings, subsidized benefits and increased salaries may all add unforeseen value to the plan in the future. A percentage value negotiated will help capture those benefits.
Make sure when dividing defined benefit and defined contribution a QDRO is used. Not using a QDRO when dividing retirement plans may expose the divorcing parties and their attorneys to a variety of unforeseen problems including taxes, early-withdrawal penalties and difficulties with unintended beneficiaries, receiving plan benefits in retirement and much more.
For timing purposes your QDRO should be finalized ahead of your completed divorce settlement and should be drafted by your attorney and financial adviser. If your spouse remarries, leaves the company or dies ahead of the finalized QDRO it may create a host of problems for you and may be difficult for you to receive already negotiated benefits.
IRA and Roth IRA plans. Dividing an IRA or Roth IRA because of divorce does not require a QDRO. Make the transfer of the IRA to an ex-spouse after the divorce is final. If the account owner transfers the IRA before the divorce is final, tax on the distribution and possibly and early-distribution penalty might be incurred.
An IRA transfer should be done by direct transfer (trustee-to-trustee). Never take a distribution from the IRA in the form of a check from an ex-spouse or that account owner will be taxed on that distribution.
When part or all of an IRA is transferred, the new owner is deemed the original account owner for their share and will inherit the original tax basis as their own. Copies of appropriate records should be maintained for tax basis of the original account.
This division process takes time and will have long-term effects on you and your life. Try to be patient. Having a professional team in place may cut down on litigation costs and prevent you from making irreversible blunders regarding your settlement. The team should consist of a divorce lawyer, a family therapist and a certified divorce financial analyst.
Remember: Ensure that you are designing a division of marital assets and retirement plans that address your current and future needs and enlist the help of your professional team to guide you.