For many divorcing couples, the assets in retirement plans represent a significant portion of marital property. Both the process of valuing and dividing these assets can be extremely complicated.
As you develop plans for dividing assets in divorce, it is important to understand the value in current terms, the potential future value, tax consequences, and the special steps that must be taken to allow these assets to be allocated in divorce. Mistakes can lead to costly delays and unnecessary tax liability, so it is a good idea to work with legal and financial professionals who understand the special handling required for retirement assets, particularly qualified retirement plans.
Why Retirement Plans Add Complexity to Divorce
Employers frequently offer numerous types of retirement plans and compensation bonus plans as incentives to their valued employees. Some of these benefits become available right away, but others require the employee to wait until the interest is vested to attain full value. It can be quite a challenge to value and divide assets that are not fully vested. It is also difficult to ascertain the current value of a defined benefit plan that is not expected to pay benefits until a future date.
Moreover, many retirement plans are considered “qualified plans” under the federal Employee Retirement Income Security Act (ERISA) and these require special handling to avoid tax issues. Plans such as 401(k) plans, profit-sharing plans, 403(b) plans, and Keogh plans are considered qualified plans. Employers generally deduct pre-tax wages to invest in these plans, and taxation on the growth of the funds is deferred until the funds are withdrawn.
So, when assets are withdrawn to provide to a spouse in divorce, one or both spouses could be hit with a tax bill for the deferred taxes as well as a penalty for early withdrawal. However, this can be avoided with the right planning.
Using a Qualified Domestic Relations Order (QDRO)
Before the administrator of a retirement plan can release funds to a former spouse in conjunction with a divorce, they generally need a domestic relations order from the court that explicitly gives the spouse the right to receive a disbursement. If that order meets certain requirements, it is considered a Qualified Domestic Relations Order, generally known as a QDRO. When funds are withdrawn from a retirement account with a QDRO, both spouses can avoid immediate tax liability or early withdrawal penalties. However, funds received by the non-earning spouse may need to be reinvested into another retirement fund to avoid current tax liability.
A QDRO must be drafted carefully to contain elements that satisfy government requirements. A law firm or legal specialist typically prepares the order according to the terms of the divorce settlement and presents the order to the court for approval and execution. Once the court approves the order, then the spouse obtaining the distribution from the retirement plan will need to submit it to the administrator of the plan, and it may take considerable time for the plan to approve and pay out the funds. It is important to ensure that the terms of division in the divorce decree fit with the options allowed by plan administrators, or the order may need to be redrafted and distributions will be further delayed.
California law requires that in some cases, the administrator of the plan will need to be added as a party to the divorce through joinder before orders can be established. When this is necessary, it must be completed before the QDRO can be issued.
How Much of Your Retirement Plan Will You Lose in Divorce?
The amount of funds that will be removed from a retirement plan and disbursed to a spouse in divorce will depend on many factors. First, if the couple executed a pre- or postnuptial agreement that addresses retirement plan assets, the terms of that agreement will be followed over the default terms under the law.
If you don’t have an agreement, then retirement assets are subject to division as community property. The value of contributions to the plan made during the marriage and the value of appreciation during the marriage would be split equally between spouses. If your spouse also accrued retirement benefits during the marriage, you are entitled to half the value of those. So the amount you could see taken from your retirement plan will depend on how long you were married, how much value was added to the plan during the marriage, and how much your spouse may also have accrued in their own plan.
Holstrom, Block & Parke, APLC Works to Protect Your Interests in Retirement Assets
You worked hard to build up your retirement assets, and we want to help you protect your property. The experienced team at Holstrom, Block & Parke, APLC has over 300 years of combined experience safeguarding the assets of our clients in divorce, and we understand the intricate details that must be managed to secure the best outcome with respect to all assets, including retirement plans. For a confidential consultation to learn how we can protect your interests, contact our team today.