Aviva Pinto is a CDFA, CDS and Managing Director and Wealth Manager at Wealthspire Advisors.
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When you are going through a divorce, retirement funds such as 401(k) plans and other employer-sponsored plans are generally divided. However, they are more complicated to divide than savings and investment assets and you need to consider the ramifications.
The following will detail some of the strategies to consider when researching paths to asset division.
401(k), 403(b) And Pension Plans
If you will be receiving a portion of your spouse’s retirement plan, a Qualified Domestic Relations Order (QDRO) will typically need to be issued and approved by a judge. The QDRO will detail how you and your spouse will split qualified retirement accounts, such as 401(k) or pension accounts. A benefit for the spouse making the payout from their retirement plan is that there is no early 10% withdrawal penalty (if the person is under 59 ½) by the IRS for transferring the funds to the ex-spouse.
There are a number of ways for you to take the proceeds from a pension account.
You can take the funds as a lump sum.
If you are under 59 ½, income taxes will be due and there will be a 10% tax on the amount distributed. It will also incur a mandatory withholding tax, which is 20% for federal taxes. (You may also be subject to state taxes depending on where you live.)
Roll the proceeds into another qualified plan or IRA rollover.
You will not be taxed if the funds are rolled over. If your current employer has a plan and you desire to combine them, ask the administrator if you can roll the proceeds into that plan. If not, you will have to open an IRA rollover account. You will typically have 60 days from the date you receive a distribution to roll it over into another plan or IRA. If it is not rolled over after 60 days, it can be considered by the IRS to be taxable income subject to federal income taxes. If you are under 59 ½, you will also be subject to the 10% early withdrawal penalty.
It is best to have the pension plan administrator review the draft of the QDRO before it is signed by a judge. This way you can ensure that everything you are requesting is allowed by the plan and can be executed as you had planned.
The QDRO should be very specific and tell the administrator how much of the agreed-upon distribution should be transferred to another retirement account, the account it is to be transferred to, and any distribution that is to come directly to you. If possible, have a direct transfer made so that you do not have to worry about depositing the money within 60 days.
IRAs And Rollover IRAs
If you are splitting an IRA, a QDRO is typically not required. However, you will likely want to roll the proceeds into a rollover IRA within 60 days so that the assets can continue to accumulate tax-free without tax implications.
If you take money out of the IRA and you are under 59 ½, the 10% early withdrawal penalty will typically apply. If you’re over 59 1/2, you can usually take money out without penalty, and as with other IRA withdrawals, you will report it as ordinary income for tax purposes.
If your spouse is splitting their Roth IRA, you can take the distributions without paying tax as the deposits to the account were made with after-tax dollars. However, you will still likely be subject to the 10% early withdrawal penalty if you are under 59 1/2. To avoid the penalty, within 60 days you will need to roll the proceeds into a rollover Roth IRA.
When you are required to take minimum distributions, you will have to take into account all the retirement funds you have, including what was rolled over during a divorce.
As you continue your research, you may find it best to consult with a Certified Divorce Financial Analyst (CDFA) to determine the strategy that will work best for your specific situation. A CDFA relies on knowledge of tax law combined with short- and long-term financial planning to help couples and their attorneys reach settlements.
You can find a CDFA by looking at the CDFA directory or at the National Association of Divorce Professionals. Make sure you interview a few and find one that suits your temperament and understands what you need.
The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.
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