Posted by Manisha Thakor.
You know what they say: Divorce in haste, repent at leisure.
By “they” I mean the countless divorcees out there who, looking back, wish they had taken more care when splitting the retirement assets—also with the way they distributed those assets.
Retirement portfolios are usually the most valuable asset within a household (aside from the house itself). When divvying them up between spouses, I like to first emphasize that there are different ways to get divorced—and the route you choose may very well have implications on how you end up deciding to split pensions, annuities and retirement accounts.
- If the divorce is contested, and goes through the court system, it will be up to a judge to decide how things are split. Although judges often have the gravitas of an omniscient being, they aren’t necessarily trained in financial planning. There’s a tax complexity surrounding annuities, for example, so a dollar isn’t always worth a dollar. It takes specialized training to understand the specific rules and value of an annuity, and what a fair split would actually look like. Annuity contracts are like snowflakes; no two are exactly the same. As such, you may consider bringing a certified financial advisor into the picture who can help you (and possibly the judge) fully understand the after-tax consequences of owning this type of asset.
- The other option has the potential to be more amicable and comes in three flavors: Arbitrated, mediated and collaborative. Keeping a divorce outside of the courtroom means there’s more flexibility to consider the tax nuances of complicated investments. Often there’s a team approach, involving a financial advisor who specializes in divorce settlements.
Are all assets up for grabs?
A common pitfall for divorcing spouses is assuming that everything is joint property, especially if there was no prenuptial agreement stating otherwise.
Whether any assets are considered joint or not generally depends on when they were paid for—or earned, in the case of pensions. Contributions made to an IRA before your wedding day won’t be considered joint, as a rule. Likewise, you won’t necessarily have a claim to the annuity your husband purchased prior to your big day—even if you’ve come to view the asset as shared.
You’ll need a QDRO for employer plans
As part of your divorce settlement, it is necessary to divide all “qualified” retirement benefits (such as 403(b) plans and pensions, but not IRAs) under a qualified domestic relations order. A QDRO is basically a judgment from a court, ordering the custodian of a qualified retirement plan to pay a former spouse or other dependent.
If you receive QDRO payments from your ex-spouse’s plan, moving those funds won’t trigger the 10% early withdrawal penalty (although spending them generally will). In some cases, you may be able to roll that money over to an IRA, as if it were a distribution from your own retirement plan. In others, you may be required to leave the funds in the employer plan until distribution time. But in either case, you may continue to enjoy tax-deferred growth on those payments.
Note: You can’t convert the assets directly to a Roth IRA; you’re required to roll them over to a traditional IRA first.
A QDRO cannot override the provisions of the plan.
What this means is, your QDRO payments are governed by the specific rules of your ex-spouse’s retirement plan. So even if you want to make a clean break—to take the assets and run—but the plan dictates that the first distribution cannot be made until the participant (your former spouse) experiences a triggering event (such as retirement or termination of employment), no court order can speed that process up. All plans are different, though, and the QDRO may itself be considered a triggering event.
Last word: Don’t overlook pensions and annuities in favor of the house.
Sometimes it’s hard to judge the true value of each asset on the table. A shared house represents emotional security and tangible value, but pensions, annuities and IRA balances can continue to grow in value, and don’t require the upkeep that houses do.
Divorce can be painful, with emotions running high. That’s why you need to take extra care when handling your retirement benefits. A carefully divided—and distributed—nest egg can be crucial in securing your financial future.