Division of Retirement Accounts in Divorce
We have all been taught to save for retirement. There are a number of tax deferred vehicles to accomplish retirement savings, such as IRAs (traditional, Roth, or SEP), 401(k)s, 403(b)s, employer or municipal sponsored pensions, and numerous other types of deferred compensation accounts. Typically, these accounts provide tax advantages over saving in a bank or brokerage account.
When dissolving a marriage, as part of equitable distribution, it may be necessary to divide retirement assets between the parties. The mere fact that these accounts are only owned by one spouse, as opposed to a joint bank account or a jointly owned home, does not make them the non-marital or separate property of the owner. To the extent that money was saved for retirement during the marriage, that savings is marital. But when dividing retirement accounts between spouses, there are important things for you and your attorney to consider.
First, to the extent one spouse can prove that they owned a portion of their retirement before the marriage, they may have protected the pre-marital portion as their non-marital asset. It will fall unto that spouse to prove what portion of the asset is pre-marital. The lesson here is that you should keep paperwork related to any and all retirement accounts you have at the time you get married. Being able to prove, not only the total value of the account, but how the account is invested and the number of shares owned of each stock or fund, may allow you to carve out part of the value at the time of divorce as separate property.
Second, when dividing retirement assets, it is important to determine whether or not these accounts contain “pre-tax” dollars. If so, receiving $1,000 in a traditional IRA is the equivalent of receiving a lesser amount of cash, depending on the tax bracket of the owner. Determining the exact amount of the tax consequence, however, may be very hard because there are a number of variables which may be difficult to predict. When dividing such pre-tax assets, it is a good strategy to equally divide all pre-tax assets between the parties. That way, each party has the same amount of retirement savings and presumably will be subject to the same amount of tax down the road when they withdraw the money, although even that can vary. If the parties cannot evenly divide the accounts, then the next best strategy is to negotiate an agreed tax impact percentage, and discount the value of the assets accordingly.
The third and final issue to consider with retirement savings is the actual distribution. All or a portion of retirement accounts can be transferred from one spouse to another, after a court order is entered which requires the transfer. If the account is a Qualified account under Federal ERISA laws, then a special order, referred to as a QDRO, must be entered to accomplish the transfer. Such a transfer does not create any tax obligation on the transferring spouse. Also, despite common belief to the contrary, there is an exception to the tax rule which otherwise creates a 10 percent penalty for early withdrawals from retirement accounts. That means, the recipient of the transfer can cash out some or all of the transfer, and they will only owe the federal tax on the distribution, without the extra penalty.
This is only a peek at the issues that may be involved in the distribution of retirement assets. If you or your spouse have significant retirement assets or pension benefits at the time of a divorce, it is vital that you seek the advice of an attorney to assist you with the division of these assets without incurring unnecessary tax costs.
DALE KLAUS and REUBEN DOUPÉ are partners at Klaus Doupé, a leading law firm in Naples focusing solely on marital and family law. Visit www.Marital-FamilyLaw. com or call 239-403-9800.