Common Mistakes In Dividing Retirement Assets In Divorce

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For many couples, retirement funds may be the most important of assets to divide fairly and properly, as it represents the ability of one or both spouses to afford a certain lifestyle come retirement.

In general, parties divide retirement funds by calculating the marital portion of the asset and splitting that sum equally. The marital portion will be the amount accrued from the date of the marriage until the date of dissolution. A spouse may want to trade a claim to another asset for a higher percentage of retirement funds.

Once the parties have determined either a fixed dollar amount or a percentage of the marital portion of a retirement asset, the parties have to focus on how to transfer the sum from the account of one spouse to a new or segregated account of the other spouse. It is key that all rules are followed in this procedure to assure that the transfer is tax-free and that it complies with the requirements of the plan administrator.

This last point – meeting the demands of the plan administrator – can be where spouses encounter the most costly problems. To transfer a portion of a pension, the parties must draft a Qualified Domestic Relations Order (QDRO) that a court will sign.

If the QDRO is not approved in advance by the plan administrator, the parties will have to come back to court and get a new QDRO – and incur additional expense. The timing can be problematic too – if the spouse needing the funds is relying on quick starting of the receipt of benefits.

An important piece to put into the QDRO is any rollover provision – this will assure that the funds go into the proper segregated account without any adverse tax consequences or early withdrawal penalties.

Another issue: Retirement accounts have beneficiary designations.

Typically, during the marriage, the spouse designates the other spouse the beneficiary. As the divorce process starts, the temptation will be to quickly remove the spouse as the beneficiary. However, this would be a big mistake – not only do courts prevent modifying property assets in this manner, it could also destroy the property right in the asset should the account-holding spouse die before the entry of divorce. The change of beneficiary could turn the divorce into a probate fight.

Yet another issue: Percentage distribution is always preferable to a fixed sum. Why? Because the market is never stable.

If you are the account holder and the value drops 30% by the time you have to pay out the fixed amount, you now owe your spouse way more than half the value of the marital amount. On the other side, if you are the QDRO spouse and the market value of the account goes up 30% by the time of retirement, you want to be able to claim the increase in your share, not just a fixed sum.

Finally, should either spouse wind up in bankruptcy, a pension plan (401k) is protected from creditors while an IRA is not protected. So, best to leave funds in a 401k where possible.

If you have additional questions about retirement benefits and divorce, contact us – we can help.