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Like all family and property law, divorce is a very state-specific process. How you handle a divorce and protect your assets, and what constitutes individual assets versus shared assets, depends entirely on your jurisdiction. As a result, the way retirement accounts are treated during divorce proceedings can vary widely from state to state.
The first step is usually to separate personal and marital property. In most cases, you will retain assets and debts that predate the marriage, and you will share assets and debts acquired during your marriage. This is much more complicated than it sounds because it is very easy for assets to merge over the course of a marriage and share the accumulated value.
For example, say you are 55 years old and have $800,000 in a 401(k). The most important part of this is where you live and how much of the bill was earned during the marriage. From there, a divorce court will typically divide the 401(k) based on your household’s total assets and, in particular, any other retirement accounts held by you or your spouse.
While a full discussion of this topic goes well beyond the scope of a single article, below we will explore some of the most important factors to consider.
If you need financial advice during or after a divorce, consider contacting a fiduciary financial advisor today.
Divorce courts generally do not grant special status to a couple’s tax-advantaged retirement accounts. A judge will treat these portfolios as a standard financial asset, splitting each account based on, among other things, the overall distribution of assets, the relative financial status of the parties, and an account’s marital versus personal status.
There is no tax penalty for taking early retirement funds to transfer retirement assets between divorcing spouses. This is usually done through a ‘Qualified Domestic Relations Order’ or a ‘Transfer to Divorce Order’, depending on the nature of the account.
You can transfer these funds directly to another eligible pre-tax account without incurring income taxes or early withdrawal penalties.
For example, let’s say you have $800,000 in a 401(k), of which you had $300,000 in the account when you got married. Normally you keep that $300,000. The remaining $500,000 can be considered marital property and divided between you and your spouse. You can then agree to split that money 50/50 and set up a QDRO to remove $250,000 of assets from your 401(k) and move them into an account of your spouse’s choosing.
Retirement accounts can be divided directly, with one spouse receiving the assets or cash equivalent at the time of divorce. Assets can also be shared at retirement, with each spouse receiving income or benefits according to the terms of their divorce. This is most common with a more structured pension asset, such as an annuity or a pension, which is difficult to split.
Whether you have just begun the divorce process or have already completed it, a financial advisor can help you set and plan new financial goals in light of this major life change.
There are two main ways states handle divorce assets: community or equality.
Community ownership has grown in favor so that relatively few states (nine in total) still practice it. Under this arrangement, a court will determine that the marital assets will be divided equally between the spouses upon divorce, with each spouse receiving half. For example, in this case, under a community settlement, a court would simply give each spouse 50% of the marital portion of the 401(k).
Equality, or ‘fair distribution’, is increasingly the standard model. Under this approach, courts will attempt to divide divorce assets fairly, and not necessarily evenly. The court will consider several factors, including (but not limited to) the length of the marriage, child custody arrangements, employment and career, financial and personal contributions to the marriage, earning potential, and in some cases, mistakes and bad behavior. deeds.
In the case of a retirement fund, a court may also consider issues such as the age of the spouses (who have more time to save), future Social Security benefits of each spouse, and other retirement assets each spouse owns. For example, if you are 55 and your spouse is 45, the court may give you more of the 401(k) assets because you will have less time until retirement. On the other hand, if you have $800,000 in your 401(k) and your spouse has $750,000 in his or her estate, a court can transfer few (if any) assets between two parties in a similar situation.
Whether you live in a community property state or an equitable distribution state, a financial advisor can help you consolidate the assets you receive in a divorce and build a comprehensive financial plan around them.
The truth is, there are few legitimate ways to protect your marital assets from divorce proceedings. Much of the advice on this subject concerns illegality, as trying to hide your assets or cover up their marital history could constitute fraud. As a result, most advice for moving your assets or changing their tax status is at best useless and at worst legally suspect.
Some advice recommends that you stop contributing to a 401(k) during divorce proceedings. While this will (modestly) reduce the profits your spouse can claim, it will similarly reduce your own profits, and will not change the distribution of the underlying money.
Although a financial advisor can be a valuable resource during a divorce, there are a few basic steps you can take:
Once the divorce begins, the first thing you need to do is set up your own bank accounts. Cash flow will be critical. You need to pay legal bills, start your own household, build a separate credit history, and more. You may also want to buy your spouse out of his or her share of the retirement portfolio. For example, suppose you own an $800,000 401(k) based on stock options from your employer. You may want to keep these assets invested. In that case, you may want to build up cash so you can pay your spouse the equivalent value for his share of the 401(k) and trade the cash for the more valuable portfolio assets.
Although your spouse may choose to decline your offer if he or she also prefers the long-term value of the assets.
You will also want to speak with your divorce attorney and 401(k) plan administrator immediately. It is not uncommon for spouses in divorce proceedings to attempt to sell, move or spend assets. In some cases this is an attempt to disrupt the proceedings, for example by converting identifiable securities into obscure personal property. In other cases, it is simply an attempt to destroy or devalue shared assets out of spite.
Regardless of the goal, you’ll want to address this ahead of time. It’s much easier to prevent your spouse from cashing out the 401(k) than to try to get that money back.
You want to know exactly what you own and where. Clearly document all financial transactions you make and note any transactions made by your spouse. This paperwork includes suing the beneficiaries on all policies, such as your 401(k) and life insurance policies. You do not want your spouse to retain authority or rights to these accounts, regardless of how they are divided.
Finally, pay attention to the tax status of your settled assets. For example, let’s say you have an $800,000 Roth IRA in addition to your $800,000 401(k). Don’t accept a divorce settlement that treats these as equally valuable assets because the Roth account likely has much more value than the other. Make sure you and your attorney insist on treating your 401(k) as the pre-tax asset that it is, and not the $800,000 asset it appears to be.
Protecting your assets during a divorce is difficult because they are not your assets under the law. They belong equally to your spouse. But you can put yourself in a better position by remembering to track your money and value it over the long term, after taxes.
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Divorce is stressful and painful, especially because it involves some of the most complex financial transactions a household will undertake. While it’s important to have legal and financial professionals there to help you through the process, you also need to understand exactly what’s involved.
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Have an emergency fund on hand in case you encounter unexpected expenses. An emergency fund should be liquid – in an account that is not at risk of significant fluctuations like the stock market. The trade-off is that the value of liquid cash can be eroded by inflation. But with a high-interest account, you can earn compound interest. Compare savings accounts from these banks.
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The post I’m Getting Divorced This Year at 55 With $800,000 in a 401(k). How do I protect my finances? first appeared on SmartReads by SmartAsset.
