Dividing a 401(k) and Other Retirement Assets in Divorce
You’re divorcing because you need a new beginning. However, you must also keep the end in mind. How will retirement look for you financially? How much money will you have to live on? Your divorce can have a significant impact on these questions. This post explains the division of a 401K and other retirement assets in divorce and offers some tips to keep in mind as you’re going through the process.
First, how do the courts decide how retirement assets should be divided? Under MA law, all retirement accounts in either party’s name are considered marital property. To decide how they’re divided, the courts take into account a number of factors, including the financial circumstances of the parties, income, age, health, other assets, and potential future earnings, among others. But generally, the longer the marriage, the more likely it is that the retirement assets will be divided approximately equally.
However, the parties are free to negotiate and may opt for a deal that offsets retirement money with other assets. For example, if one party wants to keep the home and cannot afford to buy the other out with cash, but has substantial retirement savings, that party may offer a greater share of retirement money to effectuate the buyout.
Types of Retirement Plans
There are generally two types of retirement plans: direct benefit plans and direct contribution plans. Direct benefit plans are plans in which the employer promises a specified payment on retirement. These are generally otherwise known as pensions. A direct contribution plan, on the other hand, is a retirement plan in which the employer, the employee, or both, make regular contributions. These are 401Ks, 403bs, IRAs, and other similar plans.
Tips on Division of Retirement Assets in a Divorce
1. For some direct contribution plans, the division is as simple as rolling over a certain amount of retirement money from one spouse’s account to an account for the other. This is accomplished by simply filling out the appropriate rollover documents and the bank then transfers the money.
2. However, for many plans, a Qualified Domestic Relations Order is necessary (QDRO). This order is the legal document that specifies exactly how the retirement account will be divided. It must be pre-approved by the plan administrator--the person responsible for dividing it and must also receive approval by the court.
3. Some plan administrators offer templates of pre-approved QDROs, which are very helpful and make the process much easier. Some parties use these templates and insert the information about the terms of retirement division per their divorce. However, there’s some risk involved in trying to handle these on your own. These forms contain some technical language and issues that may be difficult for a layperson to comprehend. Although there’s a cost, it’s generally advisable to have a QDRO expert prepare or at least review the documents before submission.
4. Remember to establish beneficiary designations before divorce. This is especially important in pensions because if the participant passes away, the other party should know whether they will nonetheless receive pension payments and how much. Beneficiary designations also affect the regular pension payout amounts for both parties: generally, the more protection there is for the beneficiary the lower the monthly payments. These are issues that should be negotiated and decided during the divorce so that both parties are clear on the arrangement and obligations going forward.
5. Be sure to avoid incurring unnecessary withdrawal penalties when transferring retirement money. All property division transfers pursuant to a divorce are non-taxable. So transferring retirement money from one party’s account to the other’s incurs no penalties. However, if the party receiving the money actually withdraws the money instead of rolling it over before age 59 ½, that withdrawal may be subject to penalties - likely 10%. Very few plans allow withdrawal before 59 ½ without penalties. Make sure it’s a rollover and not a withdrawal.
6. Of course, if a party chooses to withdraw money from a retirement account, Uncle Sam is eagerly waiting with open palms, asking for his share. Therefore, the employer may have the right to withhold a certain percentage (usually about 20%) of the cash for taxes.
7. Process the retirement division documents promptly after divorce. Don’t be tempted to let it sit or wait to do this or that first. Putting the division of retirement money on the back burner can cause unnecessary complications and confusion. Get it done as soon as possible after divorce.
If you have any questions about the division of retirement assets in divorce, don’t hesitate to contact our firm at 508-682-8060.