How Retirement Plans Get Divided in a Divorce

When a client first appears in my office for an initial consultation regarding their divorce, one of the first questions they want an answer to is “what am I (or what is my spouse) entitled to?” After getting information about the marriage history, the parties’ assets, income and their children, I give them what I call a short crash course in family law. This course starts with property division.

In family law, generally, assets that have been accumulated as a result of work efforts of either party during the marriage are considered to be marital. These assets include any contributions to retirement plans, either by the employer or the employee. Sometimes, these contributions are accumulated on top of retirement assets that were already in place on the date of marriage, which can add further complications to dividing that particular asset at the time of divorce. Here is a primer on how retirement plans generally get divided once a marriage is over.

‘Gray Divorce’ Is on the Rise

Dividing assets for divorcing couples can sometimes be a challenge no matter how old the parties are, but typically as parties get older, they also have more stuff to divide. While divorce can happen at any age, “gray divorce” — an industry term for senior citizen divorce — is on the rise. According to a recent survey of the American Academy of Matrimonial Lawyers (AAML), 61% of the nation’s top divorce attorneys say that they have seen an increase in the number of divorce cases among couples over 50. In fact, in 2014, it was reported that the percentage of seniors getting divorced has doubled since 1990.

Determining Division

Without a prenuptial agreement, typically assets added to any retirement plan during the marriage will be considered marital. This means that if there were assets in a 401(k) at the time of the marriage, the balance as of the date of marriage can be carved off. This process involves making sure you can actually prove how much was in there on the date of marriage. (Some parties then even go as far as to try to calculate what the increase in value would be on just those assets — a task that can often be fraught with error, but can happen.) That portion gets carved off and the balance, now considered the “marital” portion, will be distributed between the parties.

A general rule of thumb is that the remaining balance would be split equally, but sometimes, in order to ensure equity and justice, a court may decide that the marital portion would be split unequally.

Divvying Up the Funds

Once it is determined, either by a court or by agreement of the parties, what portion of the retirement assets are marital, and what percentage is going to whom, then the actual division has to take place. This is where some tax implications must be considered.

Retirement assets (excluding deferred compensation and some others) are usually dollars that have not yet been taxed. The thinking is that the individual gets to save money on income taxes when he or she is in a higher tax bracket, and then gets taxed when the funds come out during retirement, when that person in now in a lower tax bracket.

So, in order to divide the funds and roll them out to one spouse from another spouse’s plan, and not have either spouse incur a tax liability (and potential penalty), Congress amended the Employee Retirement Income Security Act of 1974 (ERISA) in 1984 and passed the Retirement Equity Act (REACT). REACT created an exception to ERISA, and, thus, the qualified domestic relations order (QDRO) was born. A QDRO permits divorcing spouses to receive all or a portion of a retirement plan participant’s benefits for purposes of support and/or property division, without having a tax consequence.

When Are QDROs Required?

QDROs are required for pensions, 401(k)s, 403(b)s and other company retirement plans (government plans have their own rules for division). They are generally not required for Individual Retirement Accounts (IRAs). Rollover IRAs that were created by individuals who have separated from companies and took their 401(k) from their former employer and rolled the funds into a Rollover IRA also generally do not require QDROs for dividing the accounts.

The QDRO Process

In general, QDROs should be prepared by an attorney or another professional who specializes in drafting them. They are much more complicated than they appear. Many companies do offer model language, which can be a useful guide, and they also offer a review service free of charge to ensure that the language of the QDRO meets their guidelines.

Once it has been reviewed and approved, the order is then submitted to the court to be signed as an order, and then incorporated into the Final Judgment of Dissolution of Marriage. The signed order then gets sent to the company so that the division can be effectuated.

Dividing retirement assets can be a bit of a messy business, but can be done. You may want to consider consulting an attorney or tax professional to ensure that the division is completed properly.