How Divorce Can Affect Your Retirement
If you are getting a divorce after many years of marriage, there is no question that your retirement, pension plans and social security benefits will be affected. For many older couples, retirement accounts and benefit plans account for a considerable portion of their net worth. Therefore, it is important that the division of retirement assets be addressed in a careful and thoughtful manner. If you are getting a divorce, consider the following tips to keep your nest egg in-tact.
- Understand your retirement plan: There are generally two types of retirement plans: Defined Benefit Plans and Defined Contribution Plans. A Defined Benefit Plan is a retirement plan that guarantees a certain amount of money every month, for life, after retirement. An example of a Defined Benefit Plan is a pension. In contrast, a Defined Contribution Plan is a plan that is contributed to over time and the funds will fluctuate based on the market. An example would be a 401(K) or a 403(b). Depending on what type of plan you have, there may be restrictions on the amount of retirement assets that can be withdrawn and the method used to withdraw those funds. Failure to understand your retirement plan can lead to unintended tax consequences or a lack of necessary cash-flow at the time of your divorce. For instance, many pension plans will not pay a lump sum amount and will only pay the non-employee spouse on a monthly basis at retirement age, which could be many years in the future. If you need cash now to pay for your divorce and other bills, you may need to re-negotiate for other property to meet your financial needs.
- How much of my retirement is subject to division: Under Alabama law, assets acquired during the marriage will be equitably divided. When it comes to retirement, some of these funds may have been acquired before the marriage, and therefore will not be included in the division of assets. However, in some states, any increase in value of that separate property during the term of the marriage may be considered marital property. In short, do not assume that all of your retirement is subject to division.
- Do I need a “Qualified Domestic Relations Order?” When dividing up qualified retirement plans such as a pensions and 401(k) plans, it is essential that you (or your attorney) take steps to avoid undesirable tax consequences governed by the Internal Revenue Code and the Employee Retirement Income Security Act (“ERISA”). One of the conditions imposed by these laws is that a retirement participant’s benefits may not be alienated (i.e. paid to anyone other than the participant) during his or her lifetime. The exception to this rule is that all or part of a participant’s benefits may be paid to an “alternate payee” such as a former spouse via use of a Qualified Domestic Relations Order (“QDRO”). A QDRO will instruct the administrator of your retirement plan on how to pay your ex-spouse (typically by rolling the funds over into an IRA), while at the same time postponing income taxes until withdrawals are made by your ex-spouse.
- File your QDRO sooner rather than later: If you delay in obtaining a QDRO, such as waiting until you actually need the money or until your spouse retires, there is a chance you may lose the right to file your claim, and in turn, you may risk forfeiting any benefits you have been awarded. In addition, the QDRO process usually takes between 1 and 6 months to complete, but sometimes it can take longer depending on how complex the plan may be.
- Be careful with IRA’s: It is important to note that a QDRO is not necessary to transfer funds from an Individual Retirement Account (IRA). However, care should still taken when addressing the division of these types of retirement accounts. Otherwise the account owner may be assessed taxes and penalties. In order to avoid tax liability, it is important that you check with the IRA financial institution before the divorce to find out its procedures for IRA transfers and whether you you will need a copy of the divorce decree. Most financial institutions require that the transfer of the IRA be directly addressed in the divorce decree and any transfer take place only after the decree has been entered. Furthermore, the transfer should take place either by changing the name on the IRA account or by directly rolling the account over into another IRA. If the account owner takes a distribution from the IRA in the form of a check to the ex-spouse, that account owner will be taxed on that distribution.
The fact is that retirement accounts can be divided up the tax-smart way or the tax-dumb way. Make sure that your divorce attorney knows his taxes in addition to his divorce law. For more information about retirement and divorce, contact The Yeatts Law Firm today.