Don’t Pay For Your Divorce With a 401(k)

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Divorce can be a costly endeavor.  Whether you initiate the proceedings or not, you will need to retain the services of an attorney.  Further, it is likely that one spouse will move out during the divorce, which means that the household income must support two households.  Expenses can double and pile up.

Spouses in these circumstances often find themselves without the ability to pay for all of their expenses.  If the other spouse lacks the ability to contribute (through a pendente lite order), both spouses end up scrambling for funds.

In this situation, a spouse will think of either maxing out credit cards or liquidating part or all of a 401(k).  While neither offers a good option, the latter can be absolutely disastrous.

The purpose of a 401(k) is to provide for your retirement; it is not meant for early access.  What happens if you remove funds prior to retirement?

First, you will have to pay a penalty for early withdrawal, usually 10% of the total removed.

Second, you will have to pay taxes on the sums removed, which could total roughly 40% after accounting for state, federal and local income taxes.

As you can see, early withdrawal of any sum from a 401(k) leaves you with half as much as you anticipated at the time of removal.  Just as bad, you lose all of the potential income from the retirement funds – likely thousands of dollars of future income.

It could also get worse:  if you made contributions to your 401(k) during your marriage, those contributions qualify as marital property.  As such, your spouse has a claim to half of the marital portion of the 401(k). If you liquidate the 401(k), you will now owe your spouse the sums you depleted that were marital property.

As you can see, you want to avoid liquidating your 401(k) at all costs.

You have alternatives.  First, you might have other property you could use as collateral for a loan.  Or, you could take a loan against your 401(k) – but the downside here is that you will lose the earning power of the amount you remove and slowly pay back.

Bottom line: before thinking of taking out funds from your 401(k) speak with your attorney and financial advisor before doing so.

If you have questions about paying for divorce with a 401(k), contact us – we can help.

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