Managing Retirement Funds in Divorce

Any retirement funds are considered communal property in a divorce. This means each party has equal entitlement to the funds, regardless of who contributed, in a state that uses communal property laws. Most states do use this system of asset division, but some divide down the middle, while others use a different system. First, find out the communal property laws in your state, and then consider the options you have to resolve retirement fund disputes.

Types of Retirement Funds

The type of retirement fund you have contributed to will affect the property laws it falls under. Nearly all forms of funds are considered communal, including IRAs, 401(k)s, ERISA funds, military and veteran’s benefits, and stock options. The few funds that do not go into communal property division include Social Security benefits, compensation for on-the-job or military injury, and railroad retirement benefits. Using this information, determine which of your accounts will be allocated to both parties in a divorce.

Options to Settle Property

There are two primary options to settle the division of communal retirement funds. The first is to offer a present-day valuation to one spouse. In this scenario, the spouse keeping the retirement plan offers a buy-out of the other spouse’s portion. The buy-out is calculated at the present-day value of the spouse’s share of the fund. The asset can be in any form, including cash, stocks or property. Both parties must agree to this option prior to settling the account in court. A second option is to divide the retirement fund into two accounts. In this case, the spouse holding the fund will see a reduction of his or her savings by a proportion equal to the state law, typically 50 percent. The spouse not on the plan will set up an individual account and receive 50 percent of the funds immediately. In this option, it is critical to assure you do not take on any penalties as a result of the split. For example, follow regulations to be forgiven any potential early distribution penalties from the account split. As the receiving party, you need to set up a tax deferred account equal to that you are receiving funds from in order to avoid immediate tax implications.

Non-Division of Assets

If you feel your spouse has no legal claim on your retirement benefits, you will have to fight to secure non-division of the assets. The most prevalent reason for this type of case would be the presence of a pre or post-nuptial agreement. If you have an agreement, you may have agreed to keep retirement accounts separate in the case of divorce. You may also be able to keep the account if your contributions occurred prior to marriage. In this case, they may not be considered communal property, depending on the laws of your state. In the absence of an agreement, however, this exception can be difficult to obtain. It is preferable to enter an agreement early in your marriage if you determine your retirement plan is worth significantly more than your spouse’s at the time of marriage.

Are retirement funds transferred due to a QDRO subject to taxes and penalties?

Retirement funds transferred due to a qualified domestic relation order (QDRO) are not subject to penalties as long as the transfer is done according to IRS regulation. This generally means the transfer must occur within a short period, typically 30 days, through a legal rollover procedure. A judge may issue a QDRO on a portion of your retirement benefits if you are involved in a divorce. The recipient of the funds must set up his or her own retirement account for the transfer. If the account is not a qualified retirement account or is not the same type of account as yours, the recipient may have to pay taxes or penalties on the funds. 

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