You’ve spent years, maybe even decades, planning for retirement. Now, the prospect of a divorce may throw your plans for the future into disarray. The division of your retirement assets in your divorce settlement could have a substantial impact on what your future looks like. However, it’s possible to mitigate these impacts with careful preparation. Below, we break down the possible long-term implications of divorce on retirement plans and what you can do to minimize any adverse or unintended negative impact on your golden years.
California Community Property Laws: Retirement Funds Are Joint Property
California is a community property state, which means that any assets or debts acquired during the marriage are generally considered equally owned by both spouses. This rule applies to retirement plans as well, regardless of whose name is on the account. Whether it’s a 401(k), pension, IRA, or other retirement account, if the funds were accumulated during the marriage, they are typically subject to division. Moreover, in addition to the community obtaining an interest in the corpus of the amounts contributed during marriage, this also includes any gains and losses associated with such contributions.However, any retirement funds that were accrued before the marriage or after the date of separation (including the gains and losses associated with such accruals) are usually considered separate property and may not be subject to division. Determining what portion of a retirement plan is community property versus separate property can be a complex process, often requiring the expertise of financial professionals and legal counsel.
The Division of Retirement Plans: QDROs and Other Considerations
When it comes to dividing retirement plans in a divorce, one of the most critical documents is a Qualified Domestic Relations Order (QDRO). A QDRO is a legal order that instructs the retirement plan administrator on how to divide the retirement assets between the spouses. Without a QDRO, the plan administrator is not obligated to distribute the retirement funds to anyone other than the account holder.Drafting a QDRO requires precision and a thorough understanding of the type of retirement plan in question. The QDRO must specify the amount, or percentage, of the retirement benefits to be paid to the non-employee spouse. Not all retirement plans are the same, so it is important to have an attorney who is well-versed in the various types of retirement plans in existence. It’s essential to work with an attorney experienced in family law to ensure the QDRO is correctly drafted and executed.In some cases, it may be possible to offset the value of the retirement assets with other marital assets. This approach can simplify the division process, but it requires careful negotiation and a clear understanding of the value of all assets involved, including the specific type of retirement plan being considered. There are also potential tax considerations to consider in negotiating a settlement involving retirement assets.
The Impact on Different Types of Retirement Plans
Different types of retirement plans are subject to different rules and considerations when dividing them during a divorce.
401(k) Plans and IRAs
These are among the most common types of retirement accounts and are typically subject to division in a divorce. The portion of the account that was accumulated during the marriage is considered community property. The division can be handled through a QDRO for 401(k) plans or a transfer incident to divorce for IRAs. The receiving spouse can roll over the funds into their own IRA to avoid immediate tax consequences.
Pensions
Pensions can be more complicated to divide because they often provide a future stream of income (which is often based on certain factors which may be unknown at the time of division such as length of employment or ending salary) rather than a lump sum. The value of the pension must be calculated, which can involve actuarial analysis to determine its present value. The non-employee spouse may be entitled to a share of the pension benefits when they begin to be paid out. The specifics of how and when the pension is divided should be carefully detailed in the divorce agreement and QDRO.
Social Security Benefits
While Social Security benefits themselves cannot be divided through a divorce decree or QDRO, they are an essential consideration in the overall retirement planning process. A divorced spouse may be eligible to receive derivative Social Security benefits based on their ex-spouse’s work record if the marriage lasted at least 10 years, and the spouse seeking benefits is not remarried.
Tax Implications of Dividing Retirement Assets
Dividing retirement assets in a divorce can have significant tax implications, making it essential to approach the process carefully. For example, withdrawing funds from a retirement account before the age of 59 ½ typically incurs a 10% early withdrawal penalty, in addition to regular income taxes. However, if the funds are transferred correctly under a QDRO or transfer incident to divorce, the receiving spouse can avoid these penalties and taxes by rolling the funds into their own retirement account.The timing of the division and the method used can also impact the tax burden. It’s advisable to consult with a financial advisor or tax professional to understand the potential tax consequences and to plan accordingly.
Protecting Your Retirement During a Divorce
For individuals going through a divorce, protecting retirement assets should be a priority. Here are some steps to consider:
-
Gather Documentation: Start by gathering all relevant documentation for retirement accounts, including account statements, plan descriptions, and any other information that will help assess the value of the assets.Consult with Professionals: Work with an experienced family law attorney and, if necessary, a financial advisor who can help you navigate the complexities of dividing retirement assets.Consider the Long-Term Impact: Think about the long-term impact of any decisions made regarding retirement assets. For example, while it may be tempting to take a lump sum payout, it could have significant tax consequences and reduce your retirement security.Negotiate Wisely: During settlement negotiations, consider the value of retirement assets compared to other marital assets. It may be beneficial to negotiate for a larger share of the retirement accounts depending on how close you are to retirement age.
After the divorce is finalized, review your retirement plan and make any necessary adjustments. This may include updating beneficiaries, rebalancing your investment portfolio, and revising your retirement goals based on your new financial situation.
Navigating the Complexities of Divorce and Retirement
Divorce can significantly impact retirement plans, and the decisions made during the divorce process can affect your financial future for years to come. Understanding how retirement assets are divided, the tax implications, and the long-term consequences is essential for protecting your retirement security. At Flicker, Kerin, Kruger & Bissada LLP, our experienced family law attorneys are here to guide you through the complexities of divorce and help you secure your financial future.