Divorcing spouses have enough to worry about — from custody arrangements to deciding who gets the furniture — so it’s understandable that many couples gloss over the details of dividing up their retirement assets, trusting that things will work out.
But that’s a mistake that can be very costly. After all, for most divorcing couples, retirement accounts will be their largest asset — which means mistakes can have much larger consequences.
If you or someone you know is headed toward divorce, here’s what you need to know about splitting up retirement accounts.
Qualified Domestic Relations Order (QDRO)
This legal document establishes what rights your ex-spouse has to your qualified retirement account. Qualified accounts include pensions, 401(k)s, and IRAs.
Unfortunately, QDROs aren’t simple documents. That’s partially because there are a maddening number of details to worry about with each type of retirement account, and neglecting an important detail can make a huge difference in your retirement.
For instance, defined benefit plans (like pensions) will often offer surviving spouse benefits. However, if all your QDRO says is that the pension will be split in half for each spouse, it doesn’t account for what will happen if the employed spouse passes away before starting to receive benefits — which could leave the surviving spouse with nothing.
In addition, it’s important to be careful how you designate what each spouse receives. For instance, if you state that the non-employee spouse were to receive $50,000 of a $100,000 retirement account, that leaves the employed spouse vulnerable if the account suddenly loses value. It’s better to state what percentage of the account will go to each spouse.
One of the reasons QDROs are so important is the tax implications of splitting retirement money without one. Incorrectly transferring assets from your retirement account to your ex’s account will mean Uncle Sam treats the transfer as a full distribution, and you’ll be stuck paying the tax bill on money that went to your ex-spouse.
If the only type of retirement account being split is an IRA, however, a QDRO may not be necessary. These accounts can be split using a divorce decree or a property settlement agreement and won’t be considered taxable. However, you’ll still need to tread cautiously to be certain the transfer’s handled correctly, so you’re not hit with taxes on the distribution, or the 10% penalty for early withdrawals. Work with your divorce attorney and a tax professional to make sure your attempt to be fair to your spouse doesn’t bite you.
An easy detail to overlook during your divorce is the beneficiary designation on your pension plan. You’ll have to specifically update the beneficiary for your account, or you may find that your ex-spouse receives money that you intend for someone else.
The Bottom Line
As if dissolving a marriage isn’t overwhelming enough, dealing with the division of retirement assets can be confusing and costly. Protect yourself and your ex by partnering with legal and financial professionals who are well-versed in this aspect of divorce proceedings.
Have you had to divide up retirement assets during a divorce? Anything you’d like to add?
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