Tips for Dividing Retirement Funds in a Divorce

Many people have retirement benefits, like a 401(k), through their employment. Others have individual retirement accounts (IRAs). What happens to these accounts in the event of a divorce?

As with any item of property, we begin with the fact that in Missouri all property obtained during the marriage is presumed marital property. Hence, if a spouse takes a job during the marriage with a retirement benefit or opens an IRA during the marriage, those accounts will be considered marital property. At the time of divorce, the court will allocate to the other spouse his or her half-share of the marital portion of the retirement account.

One of the most important steps is to quickly get a complete understanding of all retirement accounts subject to division at divorce. This is particularly important if you haven’t been handling the finances in the marriage and aren’t aware of the details of each account. You or your financial advisor can notify the plan administrator of any retirement accounts that a divorce is pending. Then, typically no changes can be made to the account, such as withdrawals or loans. 

When reviewing your financial situation, it’s important to note whether funds are considered marital property or separate property. In Missouri, if retirement resources were collected during the marriage, they would be divided during a divorce. However, if contributions were made to accounts before the marriage, they would not be considered marital property and subject to division. It’s critical to have documentation for what existed before marriage as well as those earned during the marriage. For more complicated retirement assets, the plan documents and any information about vesting will need to be provided to determine the portion that could be marital versus what could be kept separate. Then check the details of your retirement plans. Some offer the option of a lump sum payout when you are eligible versus monthly payments. Also, take note of whether there are survivor’s benefits or early retirement subsidies.

If you and your spouse don’t want to have financial connections, it’s often common to offer something in place of retirement benefits that is of fair value. This could be cash or property. It is important to be aware of the relative liquidity or potential tax consequences attached to an asset to be received in a divorce. For example, the equity in a house cannot readily be turned into cash. Although a retirement account might be more accessible, you have to pay taxes and maybe even penalties. Even with these considerations, it may still be in the best interest of both spouses to take different types of assets rather than trying to divide all of them.

So, if it’s your account, you may want to offer a lump sum to your spouse or a tradeoff for another asset, like the house. Often, if the marriage is short or there’s a long time before benefits, a spouse will opt to do this so they aren’t tied financially forever to their former spouse. Be sure to follow IRS rules so that you don’t pay penalties for withdrawing retirement funds too early. 

Let’s take a simple example. If spouse A began working at a company during the marriage and ten years later, the marriage ends in divorce, spouse B will have a half interest in the value of the retirement account accumulated during those ten years.

What exactly is the value of the account? In an IRA, it is easy to compute because the IRA will have a definite value at the time of the divorce. In our example, let’s say after ten years the account has a value of $200,000. Each spouse will have a claim to $100,000. To effect the transfer of the marital share to the other spouse, the court will enter a Qualified Domestic Relations Order (QDRO) which allows a tax-free transfer of the funds from the account of one spouse into a new account for the other spouse. For a 401(k), the value determination can be complicated by vesting rules that may require a certain number of years of employment before one can claim full value. But aside from those qualifying rules, the valuation process mirrors that of the IRA.

What happens if a spouse had been working for a company prior to marriage and already established a 401(k) or IRA? In that situation, the court will look to the total years of contribution and find the percentage of those contributions that are marital, and divide that marital share. So, for example, if a spouse has been employed for 20 years at a company but married for only 5 at the time of divorce, the court will have to divide only 5/20, or 25%, of the total value of the account, so that the other spouse will receive 12.5% of the total account value.

Not all retirement accounts are immediately liquid. Some 401(k) accounts may not have vested, as noted, or may have strict rules that they cannot be touched until retirement. For those accounts that are liquid upon divorce, liquidating the funds has severe consequences, usually in the form of penalties for early withdrawal and taxation as income (and potentially capital gains). Also, by claiming the funds early, a spouse loses future income earned if the funds had been allowed to continue to grow.

Divorce can, of course, be complicated, and the separation of finances and retirement funds can be a significant part of that process. Because of the complexity of dividing current and future funds, you might want to consult an expert to help. For example, a certified divorce financial analyst (CDFA) specializes in dividing assets and debts during a divorce. They can do research on the existing retirement plans, collect documents, do a cash flow analysis, research tax information, and identify the initial financial picture.

Should you need the assistance of an experienced divorce attorney in Creve Coeur and O’Fallon or have questions about your divorce situation, know that we are here to help and ready to discuss those questions with you.

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