A significant amount of a married couple’s assets may be saved in the retirement plan. When the two spouses divorce, certain laws apply as to how the plan should be divided.
Learn from divorce lawyer Charles M. Green about how retirement plans may be handled in a divorce. If you have further questions or would like to explore options for your case, we encourage you to contact our offices for an initial consultation.
Understanding the Different Retirement Plans and Tax Implications
Plans usually fall into two categories: defined benefit and defined contribution.
Defined benefit plans are those in which a set formula determines the amount a person gets. Usually, it’s a plan offered by an employer to employees, and the formula is based on the years of service, age of retirement, and highest salary earned.
Defined contribution plans work differently. Contributions to the plan and the growth of these contributions over time determine the amount a person receives. Likely, you are familiar with examples such as the individual retirement account (IRA) and 401(k).
When you get a divorce, it’s necessary to understand the value of each of these plans. Defined benefit plans may require the help of an actuary. Generally, defined contribution plans are simpler to value.
Whichever plan is in question, you should be aware of the tax implications. Typically, a defined contribution plan like an IRA hasn’t been taxed. If you receive funds from these accounts as part of a divorce, they may be taxed later on. Courts may not take this into account when they establish the money you will receive as the tax is not “immediate and specific.”
How Plans are Divided after a Divorce
Over the years, benefits have been divided in different ways. The present-day practice is to use either in-kind division or cash-out division.
With in-kind division, the court establishes a formula for which party gets what benefits, and the division happens when the plan beneficiary starts drawing funds. Usually, the formula takes the portion of benefits earned during the marriage and before separation and gives the other spouse one-half of this amount.
Cash-out division, more formally known as “actuarial present value,” keeps the benefits with the spouse who earned them. That spouse becomes responsible for paying the other party an amount equal to his / her community interest in the benefits.
The Process for Receiving Funds from a Retirement Plan
To avoid significant tax concerns with an in-kind division, you will need to divide the retirement plan using the process established by the law. Usually, this means getting a “Qualified Domestic Relations Order,” or QDRO.
The QDRO establishes your right to receive all or a portion of the benefits payable to your spouse. It lets you take your share of a plan and move it to a rollover IRA in your name alone without immediate tax consequences.
Our law practice can advise you about certain rules, restrictions, and variations. For example:
You don’t need a QDRO if you are just moving funds from one IRA to another.
Rollovers must take place within 60 days.
Different rules apply for a tax-sheltered account.
Again, we recommend working with an attorney to verify that you and your spouse are handling the assets correctly.