Dividing a 401(k) and Other Retirement Accounts in Divorce

Learn the basics about dividing retirement accounts in divorce.

If you're contemplating a divorce, you may have questions about the division of retirement benefits, including a 401(k). This article provides a basic overview, but only an experienced family law attorney can assess your situation.

Divorce and the Division of Assets

Courts handle the division of divorcing couples' assets differently in every divorce case. The end result depends on both the law of the state where the divorce case is pending and, of course, the specific facts of each case.

Property Division Basics

There are two types of property division in divorce, depending on where you live: community property division and equitable distribution.

If you live in a "community property" state, the law considers all assets and debts acquired during the marriage as "community property." Community property means that both spouses own the property jointly, and the court will divide the property equally (50/50) between the spouses at divorce. This can include contributions to retirement accounts such as 401(k) accounts.

If you live in a state that uses the "equitable distribution" method of dividing property (which is what the majority of states follow), your state's courts will divide property between couples in a way the judge hearing the case believes is equitable or fair, but not necessarily equally.

Equitable distribution states have different rules on dividing property. Courts must first categorize all property as marital (joint) or separate, and then the judge can divide marital assets equitably. If the court declares any property as separate, the judge will award the property to the owner spouse and will not divide it in the divorce.

Different Types of Retirement Accounts

Retirement accounts, like 401(k) accounts or Individual Retirement Accounts (IRAs), are commonly a couple's largest assets. Individuals with 401(k) or similar accounts typically fund the account while working throughout the marriage. Your employer may offer a matching contribution, which increases the balance available when you retire.

An IRA is like a 401(k) in that they both offer valuable tax benefits, but an IRA has a wider variety of investments, usually doesn't have the same fees as a 401(k).

A pension plan is a retirement account that requires an employer to deposit funds into a pool set aside for an employee's future benefit. Many teachers, firefighters, and police unions utilize pension plans. Employees can invest additional income into their pension from their wages, and employers can match the contributions.

Dividing Retirement Accounts

Agreements between spouses

Like real property, such as a marital home, personal property, and bank accounts, retirement accounts are up for grabs during a divorce. Many spouses would rather hold the reins of a divorce's property division aspect than leave it up to a judge. And the court allows spouses to dictate the division. This means you can work directly with your spouse to decide who will receive assets, such as a retirement account.

If you reach an agreement, you (or your attorneys) should write it down in a document called a "marital settlement agreement" or "divorce settlement" so there is no dispute later about who agreed to what.

During the divorce negotiation process, spouses often make trade-offs. For example, you may ask to keep your entire 401(k) in exchange for some other asset. Spouses should speak with independent attorneys before signing any agreement that finalizes the division of marital assets. A knowledgeable attorney will not only tell you the laws in your state but will also ensure that the proposed agreement is in your best interest now and in the future.

Alternative dispute resolution

If communication lines are damaged but not broken, divorcing spouses should consider other methods for divorce negotiations, such as mediation or other forms of collaborative proceedings. Choosing mediation or collaborative divorce allows you to take some of the control back. These alternatives are great for couples that are willing to negotiate and come to an agreement. But, as stated above, when a couple can't agree, a judge will have to decide.

Court intervention

It's no secret that if you're divorcing, you may not be on the best of terms with your soon-to-be-ex-spouse. In cases where communication and negotiations fail, and you and your spouse can't agree, you can use the legal system to handle contested aspects of your divorce.

Courts will make decisions on asset division based on various factors, again depending on the state's laws where the divorce is taking place. Factors may include the amount of money each spouse earns and each spouse's roles in the account's contributions.

How Does the Court Split Retirement Accounts After the Divorce?

The first step in dividing retirement accounts is for the judge to determine what assets qualify for division (community property vs. equitable distribution.) Next, the court must decide what percentage of the account is up for grabs.

If you contribute to retirement accounts during marriage and before or after your marriage, you will have to calculate the amounts that you contributed at each time to figure out how much is part of the marital estate. The dates that go into the exact calculation will depend, in part, on your state laws regarding dates of separation and premarital contributions.

Qualified Domestic Relations Order for 401(k) and similar accounts

Once the court determines the specific amounts, it will issue a court order detailing the division. Typically, the next step is for the spouses (and their attorneys) to draft a Qualified Domestic Relations Order (QDRO), instructing the retirement plan administrator to divide the assets. Most attorneys will hire a QDRO company to prepare the final document, which includes case-specific details and state-specific required language in the final product.

Once both spouses approve the QDRO, they will sign (along with their attorneys) and return the document to the court for the judge's approval. Once the judge signs the document, the attorneys can mail the QDRO to the plan's administrator. In most cases, couples will split the fees to create a QDRO account. If you're concerned about the cost, you should ask the judge to include payment requirements in your final divorce order.

QDRO's are the most common method of dividing retirement assets. Spouses can choose an immediate cash-out of their portion of the 401(k), but may face a penalty for early withdrawal. Others may choose to defer taking a distribution until the account owner retires. In that case, you can choose a lump-sum payment or request regular payments.

The most common action spouses take is to roll their portion of the assets into a new 401(k) account by requesting a direct transfer. How you proceed will greatly depend on your financial situation, and you should seek legal advice before you decide.

Dividing an IRA

When dividing an IRA, the couple doesn't need to go through the QDRO process. Instead, couples can request a direct transfer, or "a transfer incident to divorce." The account owner will order the IRA plan administrator to transfer the necessary assets directly to the other spouse's new IRA account.

Another option for IRAs is "renaming" the accounts. The owner-spouse opens a new IRA account, places the other spouse's name on the old account, leaves the appropriate funds in the old one, and transfers the remainder into the new account.

Tax Implications of Dividing Retirement Assets

Tax implications for retirement assets differ depending on various factors, including the plan type. Most times, retirement transfers are tax-free. Sometimes, however, the plan defers the tax until the participant receives or withdraws the retirement funds. You should consult a Certified Public Accountant (CPA) or tax attorney about the best way to deal with the specific retirement accounts in your divorce.

Normally, taking a distribution from your retirement account before reaching retirement age counts as an early distribution, which incurs a 10% penalty fee. However, if you're disbursing retirement funds after a divorce settlement, there is no early withdrawal fee, as long as you transfer the funds according to the divorce order.

Getting Legal Help

If you have questions about the property division in your case, you will need to contact an experienced family law attorney to find out your rights. An attorney can simplify the divorce process and help you understand how the court may divide your assets.

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