How To Divide Retirement Accounts in a Divorce

Your household followed sound financial advice and contributed to retirement accounts. However, now that you are involved in divorce proceedings, the retirement savings are the subject of your property division. Whether it’s part of a divorce settlement agreement or outlined in the divorce decree, retirement assets can constitute one of the largest categories of assets in a divorce settlement.

Unlike dividing a bank or brokerage account, dividing certain retirement assets takes some legal effort. Therefore, working with an experienced local divorce attorney and financial advisor is critical to avoiding potential pitfalls.

Types of Retirement Accounts in Divorce

Ex-spouses will often seek to divide retirement assets during the division of assets. It’s an important issue during the divorce process. After the marital home, retirement assets can be the next largest category of marital assets. These assets can include defined contribution plans, such as:

• 401(k)s
• 403(b)s
• Profit-sharing plans
• Employee stock ownership plans (ESOPs)
• Thrift Savings Plan (TSP) (used by federal employees)

These qualified plans allow account holders to save for retirement as long as the plan administrator meets specific IRS requirements.

Other retirement accounts, such as individual retirement accounts (IRAs) and pensions, can also be subject to a marital property distribution.

Understanding Qualified Domestic Relations Orders

Most retirement plans require an ex-spouse to file a qualified domestic relations order (QDRO) with the plan administrator before the plan can pay any portion of a participant’s retirement account benefits to an ex-spouse.

A QDRO is a judgment, decree, or court order for a retirement plan, excluding an IRA, to pay alimony or marital rights (or child support) to a spouse, former spouse, or other dependent of a participant. A QDRO must contain specific information, such as:

• The participant and each payee’s name and mailing address
• The percentage or amount of the participant’s retirement benefits to be paid

The QDRO can only award the amount of retirement funds that are available under the plan. The plan participant is subject to income tax for any payout distributed to a child or other dependent.

An individual may be able to roll over tax-free all or a portion of a distribution received from a qualified retirement benefit plan. The receiving spouse can do so just as if they were the employee account owner receiving a plan distribution.

Tax Implications of Dividing Retirement Accounts

With the amount of cash out that can be involved during the division of retirement assets, it’s critical to understand the legal and tax consequences of dividing retirement assets.

For example, IRAs cannot typically be transferred, gifted, or assigned during one’s lifetime. However, this is an exception in divorce cases. Once the court grants a divorce, the divorce settlement agreement or divorce decree is delivered to the plan administrator to “split” the IRA in a tax-free direct transfer per the agreement’s terms.

An IRA transfer incident to divorce is the only way to split an IRA account tax-free during a divorce. If the receiving spouse takes the marital portion of the traditional IRA in a lump sum distribution instead of a rollover, they could face taxes and early withdrawal penalties. Taxes and penalties can include:

• Income taxes at ordinary income rates on the full amount withdrawn
• 10% early withdrawal penalty for those under 59½
• Loss of retirement savings that have the potential to compound over time

Each type of account, such as a pension plan, a Roth IRA, or a 401(k) plan, has its own set of transfer rules that must be considered to avoid unnecessary taxes and penalties.

Ensuring a Fair Division of Retirement Accounts

It’s critical to take steps to achieve an equitable retirement account division. A couple of options for dividing retirement accounts include:

• Present-day buy-out: The spouse receiving retirement benefits from another spouse trades the present-day value of their interest in the retirement benefit for an asset of equal value, such as property or cash.
• Dividing into two accounts using a QDRO: This legal order can protect tax benefits of retirement accounts or pension plans to equitably divide assets during divorce.

“Equitably” does not mean “equally.” A court can take several factors into account when dividing assets, including the following:

• The earning potential of each spouse
• The length of the marriage
• The amount of the retirement assets considered separate property
• Tax implications
• Child custody
• The availability of other assets

An accounting or financial professional can help provide a valuation for retirement assets. Your family law attorney can connect you with the appropriate resources if needed.

Negotiating Retirement Account Division

A divorce lawyer can help willing parties with the negotiations and devise a plan for the division of assets. Your attorney can provide legal advice regarding equitable distributions for retirement assets appropriate in your situation under federal and state law—whether you live in a community property state or one that follows the common law for equitable distributions.For guidance on the division of retirement accounts in the event of divorce, speak with an experienced local divorce lawyer.