Craig: Dividing your retirement plan in divorce
Traditionally, January is the busiest month of the year for divorce filings. There is no added legal benefit to filing this month but many think it is most popular because the Christmas holidays have caused an imminent filing to be pushed off. Of course, this year might even be busier than most because of the uncertain economy. Here are some tips to help you understand one of your largest marital assets and some details of dividing it with your soon to be ex-spouse.
Dividing retirement plans. A portion of a retirement plan earned during your marriage can be categorized as a martial asset. The non-owner spouse can receive their share of the future benefit or the benefit can be future valued and offset. These plans include 401(k), 403(b), pension plans, IRA plans, and more.
401(k), 403(b) and pension plans. Dividing an employee-sponsored plan like this between divorcees requires a Qualified Domestic Relations Order (QDRO). This legal document divides the retirement benefits of a work related retirement plan. Not using a QDRO may expose the divorcing parties and future withdrawals to taxes and early-withdrawal penalties.
Plan sponsor approval. The plan sponsor needs to approve the QDRO/proposed division ahead of the court. They will have strict stipulations about divisions of their plan in divorce and will have the final approval in how the agreement is drafted. They can show you a sample QDRO for your review.
Use percentages when negotiating. Negotiate benefits you are dividing as a percentage instead of a hard dollar amount, to guard against market volatility; if underlying plan investments lose value (or gain value) between the time the divorce is filed and the day the account is divided one spouse may be awarded more than the other. Using percentages insures the agreement remains intact and avoids the inequity of having one spouse owe the other more than was intended due to market volatility.
Your QDRO should be finalized ahead of your completed divorce settlement and should be drafted by your attorney and financial adviser. If your spouse remarries, leaves the company or dies ahead of the finalized QDRO it may be very difficult for you to receive negotiated benefits.
IRA and Roth IRA plans. Dividing an IRA or Roth IRA because of divorce doesn’t require a QDRO. Make the transfer of the IRA to an ex-spouse after the divorce is final. If the account owner transfers the IRA before the divorce is final, they might be taxed on the distribution and possibly incur an early-distribution penalty.
An IRA transfer should be done by direct transfer (trustee-to-trustee). Never take a distribution from the IRA in the form of a check from an ex-spouse, that account owner will be taxed on that distribution.
When part or all of an IRA is transferred, the new owner is deemed the original account owner for their share and would inherit the original tax basis as their own. Copies of appropriate records should be maintained for tax basis of the original account.
Have patience. This process will have long-term effects on you. Having a professional team in place may cut down on litigation costs and prevent you from making irreversible blunders regarding your settlement. The team should consist of a divorce lawyer, a family therapist and a certified divorce financial analyst at a minimum.
Remember: Insure that you are designing a division of marital assets and retirement plans that address your future needs and enlist the help of your professional team to guide you.
• Graham Craig is a certified divorce financial analyst and financial adviser. Email firstname.lastname@example.org