Retirement accounts get divided in divorce like other marital assets, such as a home, car, and bank account. It doesn’t matter that such accounts are titled in the name of one spouse only. In Connecticut, all assets owned by the parties at the time of the divorce are subject to equitable distribution regardless of who owns them and how and when they were acquired unless a prenuptial or post-nuptial agreement states otherwise. While spouses have rights to each other’s accounts, some unique rules apply.
Taxation Issues
IRAs (other than Roth IRAs), 401(k)s, and pensions are taxed when funds are withdrawn. Penalties may also apply to early withdrawals before age 59 ½ in the case of many accounts. This could be problematic in divorce because transferring money to the non-titled spouse could result in a large tax bill. To avoid this, there are different ways to transfer the funds depending on the type of account to ensure no taxes are paid.
IRAs
Money in an IRA account can be divided in divorce tax-free by doing an IRA-to-IRA transfer. Known as a “transfer incident to divorce,” the IRA owner rolls over a portion of the account into a new IRA belonging to the other spouse. This process is a simple matter that can be handled in a matter of days. It does not require a separate Court Order and can be accomplished by the parties without an attorney.
401(k)s
A 401(k) is a “defined contribution plan” where money is deposited in an investment account sponsored by an employer. It is a type of “qualified” retirement plan because it gets special tax treatment. The only way to divide the account without being taxed is to use a Qualified Domestic Relations Order (commonly referred to as a “QDRO”). A QDRO is a Court Order instructing a retirement plan administrator to divide a retirement account between parties.
As defined contribution plans, the division of 401(k)s is relatively straightforward unlike with a pension plan. The 401(k) has an ascertainable present value and the designated portion of the account can be paid in a lump sum to the other spouse. The payment should be rolled into an IRA or other qualified retirement plan belonging to the other spouse to avoid early withdrawal penalties.
Qualified Pensions
As with 401(k)s, qualified pension plans must be divided using a QDRO to avoid taxation. However, pensions are “defined benefit plans,” which provide retirees with a pre-determined monthly retirement benefit. The amount is based on a formula that considers years of service and salary of the employee. Payments do not start until retirement. As a result, at the time of the divorce, there may not be an ascertainable present value allowing for a lump sum payment. With a QDRO, the other spouse can receive a portion of the monthly benefit at the time it is paid out to the owner spouse. Alternatively, financial experts can be brought in to calculate the present value of the pension and the parties can negotiate a buy-out. In a buy-out, the non-titled spouse receives an equivalent value in other marital assets in exchange for giving up rights to the pension.
Non-Qualified Plans
Executives and key employees of a company may have deferred compensation plans, executive bonus plans, and other benefits that are not qualified under ERISA for special tax treatment. These cannot be divided between the parties even with a QDRO. Instead, one spouse can buy out the other spouse’s right to these funds by giving other equivalent assets. However, financial experts will be needed to determine the present value of the plan in order to divide it.
Alternatively, the spouses can use an “if, as, and when” division where the titled spouse pays a percentage of the benefits to the non-titled spouse once the plan goes into pay status.
Retirement accounts may represent a significant portion of your marital assets. Accordingly, it’s essential to work with an experienced attorney who can help ensure these assets are valued and distributed fairly. If you are considering divorce, contact our firm to learn how we can protect your rights.
