How 401k’s Are Affected During Divorce and How to Protect Your Nest Egg
A 401k (or other similar retirement vehicle like an IRA, pension, or annuity), is among the most valuable and complicated marital property in divorce. Due to its status as a retirement asset, many divorcing couples initially overlook it. When asked to list marital property, a divorcing spouse remembers this account may have been regularly funded throughout the marriage. What was a comfortable nest egg for retirement becomes a marital asset that must be divided with an ex-spouse.
Dealing with Your 401k During Divorce
When dealing with a 401k during divorce, an investment plan administrator must be consulted and a family lawyer and accountant are highly recommended to help you understand exactly how it is divided. Three steps are involved in dividing a 401k during divorce beginning with the ordering of a division of the 401k through the final divorce judgment. The account holder or family law attorney must then draft a Qualified Domestic Relations Order (QDRO) telling the 401k plan administrator how to divide the asset. The QDRO must be approved and signed by a family court judge and the plan administrator.
What is a Qualified Domestic Relations Order (QDRO)?
A “QDRO,” (Qualified Domestic Relations Order), lists the non-owner spouse as an alternate payee for the 401k. When collecting the entitled amount, this individual (the non-owner spouse) has three alternatives: cash payment, rolling the amount into his or her retirement plan, or leaving the amount in the existing plan and taking the distribution when the owner retires. Cash payment without tax penalty is only available at the time of QDRO approval and must be discussed with the retirement accounts plan administrator prior to entering any order in court.
In all cases, the selected distribution method must be detailed in the QDRO. When dividing retirement accounts in the divorce process, the plan administrator must comply with the Employee Retirement Income Security Act, a very confusing regulation that non-lawyers will find difficult to understand. In fact, even most lawyers are not knowledgeable of the specific inner workings which is why specific lawyers and companies exist that handle this narrow QDRO drafting procedure. One of the best at this is a company called WFA Econometrics, although they normally only work with attorneys for the final drafting. The administrator is held liable for QDRO infringement, errors, and omissions. Whether the non-owner spouse elects cash distribution, deposit of the money into a new retirement plan, or current valuation for later distribution, the lawyer and accountant should review the calculation to ensure accuracy.
Underscoring the importance of the QDRO is the fact a divorce decree is not sufficient for ordering 401k division. If the owner of the 401k dies before a QDRO is approved and fulfilled, the recipient spouse risks losing the financial benefit. Therefore, the individual should have a family law attorney prepare and enter the QDRO and file it with the judge once the divorce is finalized.
Without legal and financial assistance, divorcing couples can easily lose tax advantages when dividing this important marital property in divorce. After discussing their distribution options and determining which is in their best interests, they should work together with these experts and the plan administrator to ensure the QDRO is implemented properly. This will prevent unexpected financial impact and avoid additional penalties.
Protecting Your 401k During Divorce
Understanding the basics of how a 401k is divided during divorce is only one part of understanding your rights regarding your retirement savings. There are some ways to protect a portion of your retirement assets from being divided during the divorce process.
Frequently, people contribute to retirement accounts during their working years, watching their investments earn returns. When they retire, they receive periodic payments that fund their lifestyles. The thought that this money may need to be shared with a former spouse can be unbearable. However, this is usually the case when the account was funded during the married years. However, there are ways to protect a 401k and other retirement plans during divorce.
Prenuptial Agreements Protect Retirement Accounts
A prenuptial agreement is the easiest protection method because it allows a couple to establish marital and nonmarital property prior to getting married. Marital property is subject to division during divorce but nonmarital assets are not. A family law attorney can help an individual draft a prenuptial agreement stating that the 401k will be considered a nonmarital asset should the couple divorce. The document can also specify that 401k contributions during the marriage are nonmarital property.
Unfortunately, many couples enter marriage without considering the possibility of divorce so they do not draft prenuptial agreements. Fortunately, there are still ways to avoid dividing retirement in divorce. Contact a family law attorney immediately after deciding to divorce and ask when state divorce laws will allow voluntary 401k contributions to cease. It can take months or years to finalize a divorce and all 401k contributions made during this time will be considered marital property in divorce.
401k’s Established and Funded Prior to the Marriage
If the 401k account was established prior to the marriage, state divorce laws may permit exclusion of pre-marital contributions and earnings. The owner will receive these funds and only contributions made during the marriage will be subject to division. In this situation, it is important to maintain detailed records regarding the account so its pre-marital value can be established.
With proper planning and good recordkeeping, it is possible to protect some or all of the 401k account from property division in divorce. Retaining a family law attorney prior to getting married or consulting one promptly after deciding to end the marriage prevents a 401k account holder from losing half of the funds during divorce. Retirement years will be happy and comfortable, not filled with financial worry. The only sure fire way to know that a proper division of retirement accounts has taken place and too little or not enough divided is to work with a local expert family law attorney that understands the different possibilities that exist.