Retirement Funds And Divorce

Retirement Funds And Divorce

Other than the marital residence, the respective retirement accounts of the parties typically will be the largest assets to divide.

Retirement accounts typically fall into two categories: an individual retirement account (IRA) and employer-based retirement accounts (401(k)). An IRA is set up by an individual through some brokerage house. In the typical IRA, the individual may make a yearly contribution up to a certain amount that will have the advantage of lowering the taxable income of that individual. A 401(k) works in a similar fashion, except it is established through an employer and allows for the employer to also match contributions made by the individual. An individual can choose to change the tax structure of the account by making it a Roth IRA of 401(k), in which case the taxes are not deferred but paid upon investment – and in return, they are tax-free when the individual withdraws the sums at retirement.

When parties divorce, the court must value all marital property and divide it. Investment accounts, including IRAs and 401(k)’s, constitute property subject to division. Unless the parties signed a prenuptial agreement that excludes their retirement accounts from marital property, the contributions to the investment account during the marriage will count as marital property subject to division.

Each party will secure from their plan administrator a statement of value, indicating not only the current value of the full account but also a breakdown of contributions made prior to marriage and during the marriage. The court will find the marital portion by multiplying the full account value by the fraction of the account that is marital (marital portion sum/total value). This marital portion must be equitably divided, which usually means equal shares.

Parties can decide to offset retirement funds with other marital property to protect the full fund. If they do so, the other party should be cautious in taking dollar for dollar other property, because the retirement fund has a current value that will likely be much higher upon retirement. Also, if not a Roth account, the party receiving the distribution will have taxes to pay when withdrawing sums. If a party chooses to withdraw sums prior to retirement age, the party will have to pay an early withdrawal penalty as well, further devaluing the asset.

To assure no tax consequences from dividing the investment account, the parties will need to have the court divide the asset using a Qualified Domestic Relations Order (QDRO), which allows for a tax-free transfer of the marital portion of one account into another account for the recipient spouse. Absent a QDRO, the recipient spouse would have to pay income and/or capital gains taxes.

As you can see, retirement funds have complications that must be considered at divorce to assure not only smooth transfers of assets but also a fair division of each fund and the total marital estate.

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