Dividing Retirement Assets at Divorce
Leisl L. Langevin, CFP®, CDFA®
Senior Vice President & Financial Advisor
Divorce is a challenging transition, and one of the most complex aspects is dividing retirement assets. For many couples, retirement savings and pension benefits represent a significant portion of their net worth.
Properly splitting these assets is crucial for ensuring an equitable divorce settlement and securing your financial future. Here’s a high-level look at what to know and understand throughout the process.
Understanding the Court-Approved Process
To avoid current taxes and penalties, most retirement plans and accounts must be divided according to a court order as part of the divorce property settlement agreement. The specific steps depend on the type of retirement asset.
For qualified retirement plans like 401(k)s and pensions, a Qualified Domestic Relations Order (QDRO) is required. This court order instructs the plan administrator on how to split benefits between the employee/participant spouse and the recipient/alternate payee spouse.
Individual Retirement Accounts (IRAs) can be split via a transfer of account incident to divorce. Assets are transferred directly into a new IRA for the recipient spouse as specified in the court order.
It's crucial to follow these court-approved methods, as improper transfers or payouts can trigger taxes and potential early withdrawal penalties for the account owner.
Navigating Different Types of Retirement Plans
When it comes to defined contribution plans like 401(k)s with clear account balances, they are typically divided shortly after divorce using a separate interest QDRO approach. This creates a new account for the alternate payee spouse.
Traditional defined benefit pensions that pay future monthly income pose additional considerations. There are two main models for division: the separate interest model, where the alternate payee is treated separately and receives benefits until death, and the shared payment model, where the alternate payee only receives payouts while the employee spouse is alive.
QDROs can also secure valuable provisions, such as allowing an alternate payee access to an employee spouse's benefits earlier than normal retirement age without penalty.
Tax Implications of Dividing Retirement Assets
Understanding the tax consequences of retirement asset division is crucial. In a separate interest QDRO division, each spouse is responsible for future taxes on their portion of distributed retirement money. With a shared payment approach, taxes are paid by the employee spouse, including mandatory withholding on alternate payee distributions.
Early withdrawal penalties are avoided on split 401(k)/pension money paid out to an alternate payee spouse under age 59½ via QDRO, but income taxes may still apply. For IRAs divided via transfer incident to divorce, any distribution mistakes not following a court order can create surprise taxes and early withdrawal penalties for the original IRA owner.
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Special Considerations for Unique Retirement Benefits
Certain retirement assets and benefits require additional attention. Military retired pay can potentially be divided between ex-spouses, while government pensions may have limitations on benefit division. Employee stock options require assessment of value at different key dates, and executive non-qualified deferred compensation plans use different division methods.
The Value of an Experienced Financial Advisor
Dividing complicated retirement assets while mitigating potential tax impacts requires substantial knowledge and experience. A financial advisor who is experienced in planning for the financial impacts of divorce can provide invaluable guidance.
They can ensure accurate asset valuation and future value projections, optimize QDRO language, and keep your long-term best interests in mind throughout negotiations. They can also provide consistent, principled advice, serve as an impartial financial planner between you and your spouse, and offer in-depth knowledge of the latest tax laws, regulations, and methodologies.
It’s a good idea to look for an advisor who is a Certified Divorce Financial Analyst (CDFA®). These advisors have received specialized training in the field of pre-divorce financial planning and have demonstrated the knowledge and skills required to effectively help clients with divorce-related financial issues that will affect the rest of their lives.
I’m proud to have earned this designation myself, because it’s such a critical skill set for helping people to set a path forward for themselves during and after a divorce. Not only that, guiding my clients through life turning points such as this is one of the most rewarding parts of what I do.
If you’re going through divorce and would like the guidance of a financial adivsor and wealth management team that is experienced in managing the financial aspects of the process, reach out to us at WHZ Strategic Wealth Advisors. You can schedule a complimentary consultation right on our website at whzwealth.com, or call us at (860) 928-2341. With the right support and knowledge, you can navigate this challenging transition with Absolute Confidence. Unwavering Partnership. For Life.
Authored by Senior Vice President, Financial Advisor Leisl L. Langevin, CFP® CDFA®. Securities and advisory services offered through Commonwealth Financial Network®, Member FINRA/SIPC, a Registered Investment Adviser. 697 Pomfret Street, Pomfret Center, CT 06259 and 392-A Merrow Road, Tolland, CT 06084, 860.928.2341. http://www.whzwealth.com These materials are general in nature and do not address your specific situation. For your specific investment needs, please discuss your individual circumstances with your financial advisor. Weiss, Hale & Zahansky Strategic Wealth Advisors does not provide tax or legal advice, and nothing in the accompanying pages should be construed as specific tax or legal advice.
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