Losing Part of Your Retirement Fund in Divorce
No one gets married looking forward to getting divorced, but sometimes it’s inevitable. The divorce process can sometimes get messy, and some aspects can be complicated. One of the questions a couple might find themselves seeking answers to is how to split their assets. This is only one of the many financial concerns during divorce.
Deciding on who walks away with what amount of money may be relatively easy until it gets to the retirement funds. Mutual funds, retirement plans, and mutual benefits are usually the largest marital asset. Agreeing on how to divide it requires the intervention of an attorney. This is where you cease being a shareholder to money that was otherwise rightfully yours at some point.
To improve your chances of having the fund fairly divided, you need to familiarize yourself with the applicable rules. The rules apply to both qualified and non-qualified plans like 401(k) and IRA, respectively. Don’t forget that there are tax implications that could make the division trickier. However, an experienced law attorney will see negotiate a fair term of division for you.
QDRO for Defined Retirement Plans
In most cases, a Qualified Domestic Relation Order (QDRO) will be applied when dividing 401(k) funds. It’s a court order that authorizes the alternate payee to be paid part or all of the funds in the account. A judge has to confirm each spouse’s eligibility for a given amount of the money.
QDRO is also applicable for plans that all under the Internal Revenue Service (IRS). A closely similar court order is the Court Order Acceptable for Processing (COAP). This one affects retirement plans offered by the state, military, or federal governments.
The process of obtaining a QDRO is a complicated one. You may agree with your spouse to split the fund without the order, but unfortunately, this is prohibited. The order carries precise and detailed instructions that must also be approved by the retirement plan administrator.
The process of getting approval may entail a lot of protocol that eats into your time. Besides, the QDRO attracts a processing fee that is not less than $1,000. Remember that this doesn’t include the lawyer’s fee for processing the paperwork, and the actual cost of filing for the actual divorce.
Sometimes, you may send the QDRO to the administrator for preapproval before presenting it in court. In other cases, the administrator won’t agree to a preapproval arrangement before you’ve submitted the document to the court. With the input of an experienced attorney, you’ll navigate this step with a lot more ease.
Options in Distribution of the Retirement Funds
If you’re the payee in the distribution of the retirement fund, you have three options for receiving the money. The first option is to request a direct transfer to your personal qualified retirement plan. You can go for this option even if you don’t need the funds immediately.
The aim is to avoid having your share of the money stay with your spouse, especially if you wish to cut links with them as soon as possible. Be prepared to pay 20% withholding tax and 10% penalty if you’re under 59 ½ years old. Once the transfer has been approved, you’ll receive a check from the plan administrator. It’s your responsibility to place the fund in your qualified or non-qualified retirement plan within 60 days.
Instead of a transfer, you can also request for a rollover. Here, you’ll not receive the funds, but instead, they will change custody from your spouse’s plan to your plan.
With this option, you’ll avoid paying the penalty on the amount.
Alternatively, you can wait until your ex-spouse retires to receive your share. In this arrangement, you’ll either take regular payments or receive a lump sum. The periodic payments will only start coming through when you hit 70½ years if you want to avoid a penalty.
The third available option is to cash out your share of the fund. While this is usually the best option, it’s also the most costly. It works best for spouses with a need for immediate cash. If by the time you get access to it, you’ve not reached 59 ½ years, you’ll be subject to income taxes and a 10% penalty for early withdrawal.
Distribution of Non-Qualified Retirement Plans
If the retirement plan in question is a non-qualified one, you have two options of division during divorce. You can either change the name on the IRA or make a direct transfer of the funds. The first option is applicable in cases where the non-participating spouse is eligible to receive the whole amount in the fund.
In the second arrangement, the paying spouse directs the IRA trustee to transfer the assets to the trustee of the IRA in the name of the other spouse. In some cases, the court will allow the non-participating spouse to hold their share of the funds in the participating spouse’s IRA account.
If this happens against the owner’s wish, they can set up a new account and transfer their portion. The name of the IRA account holding the alternate payee’s share should then be changed to reflect the new ownership.
Work Out an Agreement with Your Ex-Spouse
Not unless you and your spouse can’t see eye to eye, you may want to consider an out-of-court agreement. State laws are clear on how much of the retirement fund each spouse is entitled to, but you two may agree to a fair division.
This option reduces the time and money you spend on the divorce process. If you opt for this approach, you may still want to work with a family law attorney. They will help you work out the financial complexities that are characteristic of a divorce.
Take Away: Overwhelming and Sometimes Very Unfair
The division of property in a divorce process can be overwhelming, especially where retirement funds are concerned. The law has various provisions for the distribution of the funds upon approval. Ensure you familiarize yourself with the tax implications and penalties each option attracts.
The best way to improve your chances of getting a fair share of the retirement fund during divorce is to work with a family law attorney. An attorney has a keen eye to detail and can significantly reduce the cost implications that come if the QDRO is not correctly prepared.