Dividing Retirement Accounts at Divorce
Uncontested Divorce Mediation
Posted October 5, 2015
Many divorcing couples in Colorado falsely believe that in order to divide retirement accounts at a divorce, one must liquidate that account, incur the associated taxes and penalties, then transfer the remaining proceeds to their spouse. However, by obtaining strong guidance from a Split Simple mediator and following the proper procedures in your divorce, you can avoid these negative tax consequences and make smart choices in your division of property.
The reality is that retirement accounts may be divided between spouses at a divorce without requiring one party to liquidate the account and transfer the resulting proceeds to the other spouse. However, the type of retirement plan will dictate the options for division:
1. Non qualified plans such as IRA’s and Roth IRA’s do not ordinarily require specialized retirement division orders. Instead, these plans typically will rely upon the terms of the Separation Agreement, the Divorce Decree and a subsequent “letter of instruction” in order to divide the associated account.
2. However, “qualified plans” such as 401(k)’s and 403(b)’s as well as defined benefit (pension) plans ordinarily require a document commonly referred to as a Qualified Domestic Relations Order (a “QDRO”) in order to divide. Government plans such as Colorado’s PERA as well as the Federal Government’s Thrift Savings Plan (TSP) and “FERS” have their own type of Orders that perform a similar function but are not referred to as “QDRO’s”. The QDRO will reflect the terms contained in the Separation Agreement signed by the parties.
In the event of an IRA or 401(k) type plan (a defined contribution plan) division, the retirement funds may be transferred from one retirement account to another, avoiding any tax consequences. Further, in the case of a qualified defined contribution plan like a 401(k) or TSP, the dividing order can allow for the transfer of “pre tax” funds (rather than a rollover) directly to the other spouse. This type of transfer allows the receiving spouse to obtain actual cash (rather than a retirement rollover) after the payment of income taxes associated with the transfer. The key difference here is that the receiving spouse avoids the 10% tax penalty associated with a withdrawal by the spouse holding the retirement account. This underutilized option allows many clients to obtain necessary funds at a divorce to facilitate a house downpayment or eliminate credit card debts.
In the division of a pension plan (a “defined benefit” plan) it is crucial that you determine such issues as whether the plan is “severable” (i.e. can be divided into two separate pension plans), whether the benefit has a cost of living adjustment, how the “marital fraction” (the method for division of pension plans in Colorado) will impact the division of the benefit as well as the issues surrounding survivor benefits. Your Splt Simple mediator will walk you and your spouse through all of these issues and help you arrive at a solution that will work best for your family.
Give us a call at Split Simple today and we will be happy to help you better understand the issues surrounding retirement asset division at a divorce.