What Happens to Retirement Assets in a Divorce
Many Americans contribute diligently to retirement plans. As you know, contributing a portion of your income, pre-tax, to a retirement savings plan can, over time, add up to a substantial sum over the years, or even decades.
That’s why these types of retirement assets can play a big role in divorces, especially for people who divorce later in life, when the assets have grown into large amounts. For this group, also known as “grey divorces,” their retirement account may be their single most valuable asset, exceeding the value of their home, other investments, or other belongings.
Grey Divorces are on the Rise
“Grey Divorces,” divorces among people 50+, are on the rise. According to the National Center for Health Statistics, and the U.S. Census Bureau, The divorce rate in this age group has approximately doubled over the past few decades.
In fact, for every 1,000 people aged 50+ and married, ten will get divorced. That’s twice the rate reported in 1990. Among people age 65+, the divorce rate has tripled since 1990. Among those ages 65 and older, the divorce rate has roughly tripled since 1990.
Divorce after 50, or 65 can be tricky. While child custody is rarely an issue, retirement funds and planning can be upended. A couple may have spent a lifetime saving for a retirement plan that must now change dramatically.
Moving Retirements Funds Requires Legal Orders: the QDRO
No matter which type of savings plans you’ve contributed to – an IRA, a 401(k) plans, 457 or 403(b) accounts, Governmental 457(b) plans, or a pension – retirement savings and assets will be divided in the divorce. However, how you divide the assets, and the process and legal processes you employ, will have a big impact on how you are able to use the money, when you can use it, and the tax implications associated with transfers and withdrawals.
If you contribute to a 401(k) or similar retirement plan, you may know that these types of retirement plans are protected under the anti-assignment and anti-alienation rules. That means your retirement funds are protected from creditors or other claims. A notable exception is that part or all of a retirement account could be to be assigned to an alternate payee, or, in plain English, transferred to another person, under a QDRO.
“A judgment, decree or order for a retirement plan to pay child support, alimony or marital property rights to a spouse, former spouse, child or other dependent of a participant. The QDRO must contain certain specific information, such as: the participant and each alternate payee’s name and last known mailing address , and the amount or percentage of the participant's benefits to be paid to each alternate payee.”
For all retirement savings plans (except IRAs) private settlement agreements are not acknowledged or accepted. To move money from a retirement fund like a 401(k), a Domestic Relations Order, or DRO, must be formally approved by a person or office with the authority to issue judgments, such as a court.
Once the DRO is issued, the retirement plan administrator must then approve it to make it qualified, known as a QDRO.
Interestingly, these assignations don’t have to be to your divorced spouse. With a QDRO, you can name your spouse, former spouse, child, or other recognized dependents as the alternate payee. This is especially relevant in divorces that involve custody agreements.
It’s important to know that when dealing with IRAs, the only assignee allowed is the owner’s spouse.
The QDRO Cheat Sheet
QRDOs are governed by a long list or rather complicated tax and legal laws. Here’s are a few guidelines to help you navigate through these complicated waters.
1. Find an Expert.
Consult with a qualified financial advisor to help you think through income and tax implications. It’s also smart to find an attorney who specializes in QRDOs, in addition to your divorce attorney. If you make a mistake in this area, it can be extremely costly, so it makes sense to invest in experienced guidance.
2. Without a QDRO, You May Be Taxed for the Amount You Transfer to Your Ex-Spouse.
A QDRO must be used to divide any non-IRA retirement plan, or you may get taxed as if it’s a withdrawal. The amount you transfer to your ex-spouse will be considered taxable income, so make sure you follow procedure and fill out paperwork properly.
3. IRAs are Significantly Different than other Types of Retirement Accounts.
The rules and regulations for assigning alternate payees vary substantially between IRAs and other retirement accounts. Documentation needs vary. Tax implications vary. The way you assign payees is different. Don’t make the mistake of treating them all the same. Talk to your financial advisor or tax consultant, before you make decisions, about the implications of assigning payees (or of being assigned as a payee) so you aren’t disappointed later.
4. Ask Your Financial Advisor to Analyze the Financial and Tax Implications of Divorce Agreements.
Many divorce agreements chop up assets so they can trade lump amounts, often without much regard to tax implications. For example, after-tax effects taking a house in lieu of a 401(k) payment may be substantial.
5. Update Your Retirement Plans After a Divorce.
Once your divorce is final, and transfers are made, make sure you go back to your retirement plans and change your beneficiaries. (This is also a good time to review wills, life insurance policies, deeds, and investment accounts.)
Tips for Ensuring your DRO becomes Qualified, or a QDRO
If all requirements are not met, a plan administrator may reject your DRO. A financial advisor or an attorney specializing in QDROs can help you determine why the administrator rejected your applications. The answer probably lies in the summary plan description (SPD) of your retirement account. Your plan administrator is required to provide an SPD upon request. You may also be able to access your SPD through your online account if your plan offers that option.
The SPD will map out requirements for applying for a division of plan assets, and give detailed instructions for requesting a QDRO, or at least tell you how to get your hands on detailed QDRO instructions. If the process is complicated, you should be able to ask your experienced financial advisor to assist you in the process.
What’s Needed to Get a QDRO?
You’ll need to start with a court-issued DRO that reflects the agreements you’ve made with your ex-spouse on payments. The DRO must clearly recognize the existence of an alternate payee’s right to receive some or all of your retirement account, or it must assign rights to an alternate payee and the amount due to that payee. According to the Department of Labor, you’ll need to provide the following:
- “The name and last known mailing address of the participant and each alternate payee
- The name of each plan to which the order applies
- The dollar amount or percentage (or the method of determining the amount or percentage) of the benefit to be paid to the alternate payee
- The number of payments or time period to which the order applies”
The Department of Labor also notes that there are certain provisions that a QDRO must not contain:
- “The order must not require a plan to provide an alternate payee or participant with any type or form of benefit, or any option, not otherwise provided under the plan
- The order must not require a plan to provide for increased benefits (determined on the basis of actuarial value)
- The order must not require a plan to pay benefits to an alternate payee that are required to be paid to another alternate payee under another order previously determined to be a QDRO
- The order must not require a plan to pay benefits to an alternate payee in the form of a qualified joint and survivor annuity for the lives of the alternate payee and his or her subsequent spouse”
Be Prepared, And Get Your Team Together Now
Divorce can be complicated, uncomfortable, and confusing. Mistakes can be costly and have an impact on your finances for years to come, so it pays to be prepared and to find experts who can help you make smart decisions.
If you’re considering a divorce, contact us and set up a free consultation to discuss your situation. Mirus Financial Partners can help you inventory assets, prepare for a divorce, think through tax implications, and ensure that you’re in the best possible financial position when the divorce is finalized.
Be sure to check out other blogs about finances during a divorce, including:
After the Divorce, Your New Financial Reality
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Mark A. Vergenes is President of MIRUS Financial Partners, 110 E. King St., Lancaster, PA; 717-509-4521 or [email protected] Investment Advisor Representative offering securities and advisory services offered through Cetera Advisor Networks LLC., member FINRA/SIPC. Cetera is under separate ownership from any other named entity. Neither MIRUS Financial Partners nor Cetera Advisor Networks LLC. give tax or legal advice.