The financial transactions and decisions that are part of a divorce may include a 401K plan. Determining what happens to investments, including each party’s 401K, can be confusing and challenging.
401K and Divorce- What are the rules?
Like individual retirement accounts (IRAs), 401(k) plan accounts are owned individually, not jointly. While your spouse may be named as your 401(k) beneficiary, you alone own it. The same goes for your spouse’s 401(k).
If spouses divorce, their 401(k)s and other individual holdings and any jointly held assets, such as a home or bank account, may be divided up as part of the financial settlement.
Assets in a 401(k) or other qualified retirement plan are typically divided through a qualified domestic relations order (QDRO). (Investopedia)
What is a Qualified Domestic Relations Order?
According to the IRS, A QDRO is a judgment, decree, or order for a retirement plan to pay child support, alimony, or marital property rights to a spouse, former spouse, child, or other dependent of a participant. The QDRO must contain certain specific information, such as:
- The participant and each alternate payee’s name and last known mailing address
- The amount or percentage of the participant’s benefits paid to each alternate payee.
Investopedia further explains that when 401(k) assets change hands in a divorce, the spouse who is entitled to receive a portion of the other spouse’s account is referred to as an alternate payee.
Alternate payees may have several choices for receiving their money, depending on how the QDRO is written. For example, the QDRO may provide for either a “shared payments” or “separate interest” arrangement.
With shared payments, the spouse and ex-spouse will proportionately split each benefit payment that the plan participant receives.
With a separate interest arrangement, the 401(k) account will be split into two parts, again proportionately, and the alternate payee’s share may be put into a separate QDRO account by the plan’s administrator.
In a separate interest arrangement, the alternate payee can choose to receive benefits on their own timetable. They may also have the option to take their share as a lump sum and roll it over into their own 401(k) plan or an IRA in their name.
Splitting your 401K
It is best to seek the advice of a tax or financial professional in conjunction with your divorce attorney or mediator to fully understand the impact of dividing financial assets. As we mentioned, 401K and retirement earnings accrued during a marriage generally come under the umbrella of marital assets. The critical distinction is the phrase “during a marriage.” Retirement accounts are considered marital property at a point where the funds were earned in the time that the marriage existed. Premarital retirement savings are regarded as separate property.
Your state of residency plays a significant role in how retirement accounts are handled during a divorce. Depending on where you live, retirement accounts like 401(k)s or IRAs might be deemed community property or equitable distribution.
- If one party has a 401K and the other does not, ½ the 401K will be distributed to the other party. The receiving party takes the distribution into a retirement account and avoids tax implications.
- CNBC shares this advice from Brooke Hunady, CFP: While an even split of a retirement account may be easiest, it may not always be the best solution. Bear in mind future tax implications. “For example, a $50,000 traditional IRA cannot be viewed the same as $50,000 in cash, as you will owe tax on the traditional IRA assets at some point in the future. The funds residing in the IRA will continue to grow tax deferred until withdrawn, so working with your tax and financial advisor to understand better how the division of assets will impact your financial well-being is key.”
What is a hardship withdrawal?
If you are going through a divorce and you don’t have the money to pay attorney fees, one option that may be available to you is a hardship withdrawal from your 401(k). You can make a hardship withdrawal if you have an immediate financial difficulty. Before you tap into your 401(k) to pay attorney fees, determine if this expense qualifies for a hardship withdrawal.
A 401(k) is considered a marital asset, and you are allowed to make a hardship withdrawal before age 59 ½ to pay the attorney fees and other costs related to a divorce. However, early withdrawals from a 401(k) before 59 ½ can trigger taxes and penalties, and you should use this option as a last resort.
To make a hardship withdrawal, you must prove that you have a financial difficulty that you want to meet. Some 401(k) plans require participants to provide documentation to prove the hardship. If you need help determining what documents are needed, ask your plan administrator what is required as proof of hardship. (meetbeagle.com)
Protecting Your 401K in a Divorce-Five Common Questions
Navigating through a divorce agreement or meditation can be challenging and confusing. Here are five common questions we get about protecting your 401K in a divorce:
- Is a 401k an asset? Yes IRAs, 401ks all considered assets.
- How is a 401k split in a divorce? Usually, one party can transfer part of the 401k to a similar investment or retirement account. It should be noted that under most circumstances, there are no tax penalties for this type of transfer in a divorce.
- Should I stop contributing to 401k during the divorce? That is a personal choice discussed during a divorce between the parties. If the parties do not agree to this, then the court could factor the contributions back into the final settlement.
- Is a spouse entitled to 401k in divorce? Yes. As long as it is identified as a marital asset. Rather than a separate asset.
- Can I combine my 401K with my spouse’s? No, you cannot combine retirement accounts.
Divorce Mediation- Working out an agreement to deal with your 401K
Divorce mediation is an amicable solution for couples and families to meet in a neutral and cooperative setting. Safer Divorce empowers both parties through a collaborative decision-making process, resulting in better communication between couples and reduced time for agreeable resolutions.
Each of you has worked for decades contributing to a 401K and may be willing to entertain a compromise on how to best handle splitting or withdrawing portions of the 401K. Contact us, spend a few minutes talking about your situation, and see how mediation can be a more than viable alternative to litigated divorce.
Resources: cnbc.com, Investopedia, IRS, Charles Schwab, meetbeagle.com