What Happens to IRAs, 401(k) Plans and Pensions in a Divorce?
Often retirement accounts, especially those which are involuntary or directly deducted from your paycheck, will be your most substantial marital asset other than your marital home. Any retirement benefits which have accrued or vested during the marriage are marital property. As such, they will need to be divided in a divorce. If either spouse has accrued substantial retirement benefits prior to the marriage and that spouse has not yet begun receiving distributions of those benefits, they are likely to be considered non-marital or separate property. The easiest way to avoid the potential argument over this issue is to address it in a prenuptial agreement.
Retirement accounts which will generally be divided in a divorce include traditional pensions (including military and law enforcement pensions), IRAs, Keoghs, Employee Stock Option Plans (ESOPS) and 401(k) plans. There are certain benefits which are not considered marital property. These include railroad retirement benefits, social security benefits, disability compensation and, in some states, teachers’ pension funds.
Two Ways to Divide Retirement Benefits
The first way is a present-day valuation buy-out or asset reallocation. If you are dealing with an IRA or a 401(k), the present-day value is easy to figure out – just look at your statement. A traditional pension is substantially more difficult to figure out. In the case of a pension, you are guaranteed a particular payment at a particular time – say, for example, $800 a month at age 65. But you’re only 35 now and the $800 guarantee assumes that the fund will have 30 more years of asset growth before it is required to pay out. That $800 per month doesn’t really exist now. It won’t exist for 30 years. Something less than that exists now. So, how do you decide what that benefit is worth today? Generally, an actuary or accountant must be hired to do the necessary calculations to determine the present-day value of the benefit. Once you have the present-day number for the pension, IRA or 401(k), the spouse to whom the account does not belong trades his or her half of that amount for other assets of the same value.
The other way to divide retirement benefits is to divide the existing benefit into two accounts. This can be done in pension plans, IRAs or 401(k)s. To divide an IRA, the brokerage generally just needs a copy of the court’s final decree and your final settlement agreement if you reached one. These documents should include division of the IRA funds. If the court orders the division and the split funds are rolled into a new IRA account by the receiving spouse, the transfer is without penalty and without tax. The division of a pension plan and a 401(k) plan are slightly more complicated.
A QDRO is a very detailed legal document, signed by the judge after your divorce is finalized, which will allow the establishment of a separate pension benefit for the receiving spouse in the case of a pension. It will be required to transfer a portion of the retirement funds in a pension plan or 401(k) plan from the plan participant spouse to the other spouse. It allows the rollover of a portion of 401(k) plan funds to an IRA belonging to the receiving spouse in the case of a 401(k). Your lawyer will communicate with the plan administrator regarding specific plan requirements for the acceptance of QDROs. If all requirements are met, the division is accomplished without penalty or tax. It is not treated as any early withdrawal or loan against your benefits. [More about QDRO...]
Differences Between Retirement and Other Accounts
Divorcing spouses should be careful when considering the division of retirement benefits. They are inherently different than other liquid or semi-liquid marital assets because of their purpose (retirement funding) and because of their legal baggage (early withdrawal penalties and taxes). For example, it might not be appropriate to equate $10,000 in a savings account to a $10,000 IRA. The savings account is worth $10,000 if a spouse needs it today. The IRA is worth substantially less if the spouse needs it today, because he or she will ultimately pay tax and penalty on that amount. So, it is easiest, when possible, to compare apples to apples – retirement funds to retirement funds.
Where there are not equal or substantially equal retirement funds to compare and divide, don’t forget the tax and penalty implications when considering your property settlement.