Dealing with Divorce
While we all hope our marriages will last forever, about 50% of first marriages in the United States end in divorce.1 And unfortunately, a couple who decide to divorce must typically negotiate a property settlement agreement (or seek the assistance of the courts).
Retirement assets can be divided at the time of a divorce, just like houses, cars, and bank accounts. The laws of your particular state will define which retirement benefits are marital assets (or community property in community property states) that are subject to division.
Retirement plan benefits are often among the most valuable marital assets. You and your spouse may have one or more IRAs held by various financial institutions. One or both of you may also be entitled to retirement benefits from past and current employers.
Trading Marital Assets
In some cases, one spouse may agree to waive any rights to all or some of the other spouse’s retirement benefits in exchange for other marital assets (for example, the home). With 401(k) plans or IRAs where the value is clear, trading the account balance for other marital assets is generally straightforward.
On the other hand, trading pension benefits should be done only if you’re certain that the present value of those future payments has been accurately determined. Before you give up a valuable lifetime income, make sure you’ll have other adequate resources available to you in retirement.
Employer Plan Rules
When splitting qualified retirement plan assets, such as a 401(k), a qualified domestic relations order, or QDRO, must be provided to the plan administrator. A QDRO is a court judgment, decree, or order establishing the marital property rights of a spouse, former spouse, child, or dependent of a plan participant.
Pursuant to a QDRO, you could be awarded all or part of your spouse’s pension plan benefit or 401(k) account balance as of a certain date. Be sure to consult an attorney who has experience in negotiating and drafting QDROs, especially if the QDRO may need to address complex issues such as survivor benefits, benefits earned after the divorce, plan subsidies, and COLAs, among others. (For example, a QDRO may provide that you’ll be treated as the surviving spouse, even if your spouse subsequently remarries.)
You are responsible for any taxes on benefits awarded to you pursuant to a QDRO (although the 10% penalty for early distributions before age 59½ will not apply). You may be able to roll certain distributions into your IRA to defer current taxes.
IRAs Are Different
Dividing assets in IRAs or nonqualified plans does not require a QDRO. However, a divorce decree may be needed to avoid the negative tax consequences of IRA distributions resulting from divorce. Under federal rules, owners of traditional IRAs must pay ordinary income tax on any distributions. However, if the IRA assets are transferred to the former spouse’s IRA in accordance with a divorce decree, then the IRA owner will not be responsible for any taxes on the distribution. Instead, the recipient spouse must pay any taxes due when payments are received from the IRA.
Social Security Benefits
If you were married for at least 10 years to an eligible worker and are currently unmarried, you may be able to collect benefits based on your former spouse’s work record. This won’t affect the benefits that your former spouse receives, even if he or she has remarried.
You can claim spousal benefits when your former spouse reaches the eligibility age for Social Security (if you have been divorced for at least two years), regardless of whether your former spouse is actually receiving benefits or has filed for them. But doing so before you reach full retirement age will result in a reduced benefit amount.