Dividing Retirement Benefits during a Divorce

In many cases, a person’s retirement account is the most valuable asset that he or she has, even more valuable than a marital home. This makes this area ripe for argument between spouses. It is important when going through the process of divorce to make informed decisions. Many decisions can have a significant financial impact on the lives of the couple involved.

Retirement savings are often very valuable. However, these accounts are often very complicated with the potential to impact a person’s tax situation and subject to stiff penalties if not handled properly.

Dividing Retirement Accounts

Retirement accounts are considered an asset. The amounts that are acquired after the marriage are often subject to division. When a spouse has a 401(k) or pension plan, his or her spouse is usually legally entitled to a portion of the account, assuming that there is not a prenuptial agreement, valid postnuptial agreement or other agreement between the parties to the contrary.

Tax Concerns

When dividing retirement accounts, it is important to consider the possible tax implications. When a partial interest from an individual retirement account is transferred, this amount must usually be transferred into a new IRA in the other spouse’s name. The divorce decree may discuss the transfer and how the funds should be transferred from one IRA to the other. These settlements are not usually considered taxable. However, this requires that they be transferred in the correct way. If the transfer is not made correctly, it can be considered a full distribution of the funds and there can be tax consequences. When this occurs, the spouse who receives the distribution can be taxed and the other spouse can be taxed on the transfer. To avoid these possibilities, the transfers must be specified in the divorce decree or a similar court order or written agreement. If there are other transfers that occur during separation or after divorce that are not specified, these transfers can be considered taxable. The order should contain detailed and specific information that provides details about how the transfer should occur and that provide the account number and financial institution for each account.

Another tax concern is that a spouse who is younger than 59 ½ can be subject to a 10-percent early withdrawal penalty if he or she transfers the funds before the divorce is final.

Qualified Domestic Relations Orders

If a primary breadwinner earned most of the funds held in a retirement account and the other spouse wants to protect his or her portion of the account or if the recipient spouse wants to ensure that the employer does not just pay only the employee, the spouse can seek a Qualified Domestic Relations Order. This is a separate court order, decree or judgment that divides one person’s retirement account with a spouse, ex-spouse or dependent. This allows for transfers without incurring taxes or penalties that would normally be assessed. These orders can apply to cases in which child support, spousal support or property rights are at issue. They apply to retirement funds held in 401(k), 403(b) or traditional pension plans. While a traditional or Roth IRA may not technically require a QDRO to be effective, having one in place can provide protections against unnecessary taxes and penalties. Simply because a divorce decree states that a person has a right to his or her spouse’s retirement funds does not mean that this order will be sufficient to order the actual transfer of funds. Not handling this process properly can result in significant financial consequences to the spouses, including possibly losing a significant portion of the benefits due to taxes and penalties.

The QDRO should specify the percent of the fund that is to be transferred. If a numeric amount is specified, there may be unanticipated consequences, such as the value suddenly decreasing or increasing due to market variables that adjust the proportion of the fund that is transferred.

QDROs only apply to IRS tax-qualified plans that are covered by ERISA. They do not have authority over government or military pensions.

Legal Assistance

To acquire a qualified domestic relations order, the agreement must be approved by the administrator of the retirement plan and the court. This can be a complex process that may require the special attention and input by the lawyer. A lawyer who has experience drafting QDROs may be able to ensure that all relevant issues that are related to the QDRO are incorporated into these agreements so that your rights are properly protected.

Provided by HG.org

Disclaimer: While every effort has been made to ensure the accuracy of this publication, it is not intended to provide legal advice as individual situations will differ and should be discussed with an expert and/or lawyer.
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