How Retirement Accounts Are Split in a Divorce

Retirement Accounts and Pensions are Common Assets to be Split During a Divorce

Retirement accounts and pensions typically make up a large percentage of the total assets to be split during a divorce. While there is generally no requirement to split retirement accounts, they are often targeted due to their tax deferred nature and long-term growth potential.

Attorneys and other professionals will more than likely be involved due to the complex nature of the division process.

Retirement accounts and pensions have various rules complexities that can differ from employer to employer. Therefore, you will want to make sure everything is separated and executed properly. Let’s look at the differences between common retirement plan types and break down your options.

 

What is a QDRO?

If you or your spouse has a pension or retirement plan provided by an employer, then you have the option to utilize a “QDRO” to separate the assets in the plan. This could mean splitting the account balance(s) 50/50 (or any other dollar amount/percentage).

For example, you can give your ex-spouse the entire balance in exchange for some other asset such as home equity or vice versa.

A “Qualified Domestic Relations Order” (QDRO) is a court order, decree, or judgement. The QDRO recognizes a spouse, former spouse, child, or other dependent’s interest in an individual’s retirement benefits.

QDROs are used for defined-benefit plans (what many people refer to as “pensions”) and defined-contribution plans. The following are some examples of defined-contribution plans you may be familiar with:

• 401(k)
• 403(b)
• 401(a)
• Profit Sharing
• ESOP

This is not an exhaustive list of plans in which a QDRO can be used. Also noteworthy, a QDRO can also be used for a 457 Plan which is a form of deferred-compensation plan that is common among government employees and highly compensated employees of nonprofits.

Planning Tips: Federal government retirement benefits such as the Civil Service Retirement System (CSRS) and Federal Employees Retirement System (FERS), or state provided benefits such as CalPERS and CalSTRS (California) are divisible by a Court Order Acceptable for Processing (COAP) or Domestic Relations Order (DRO).

The Federal Thrift Savings Plan (TSP) is divisible by a Retirement Benefits Court Order (RBCO).

Court orders related to the FERS and CSRS annuity programs, which are administered by the Office of Personnel Management (OPM), should be submitted to the Court Ordered Benefits branch of OPM.¹

If any of these plans pertain to you, please contact us for further guidance.

 

How Retirement Accounts Are Split in a Divorce

Defined Contribution Plans – 401(k), 403(b), Profit Sharing, etc.

When a defined-contribution plan account is divided with a QDRO, it is usually split up in terms of a percentage or dollar amount of the account balance(s). The account balance(s) to be divvied up will consist of contributions and earnings (including any employer contributions) during the marriage.

The divisible account balance does not include additional contributions by the participant and employer from the date of separation to the date the dissolution is actually finalized with the court. However, it will include any investment earnings on the alternate payees’ (non-participating ex-spouse) applicable portion of the account up until the account is actually split.

These nuances are why we do not believe doing a QDRO on your own is in your best interest, and that you go consult a qualified professional instead. You only get one chance to do this the right way!

 

Defined Benefit Plans – Pensions, Cash Balance Plans

When a defined-benefit plan (industry jargon for “lifetime pension”) is divided with a QDRO, the formulas used can be quite different because defined-benefit plans vary drastically from one another. They are also entirely different than the defined-contribution plans discussed previously.

To get started, the plan participant or “member” of the pension plan would generally ask the plan administrator for a calculation of benefits as of a specific date, such as the date of separation or retirement. This can include a pension lump sum valuation and/or projected lifetime payments starting at a specific point in time (annuity payments).

There are typically several annuity payment options such as single life only, 75% spousal, 50% spousal, etc. The formulas in determining these potential lump sum and annuity payments could incorporate the total amount of years the participant worked for the employer or was eligible for participation in the retirement benefit plan, and their compensation.

If the participant/member continues to work for that employer, the actual separation of assets in that pension plan may not be allowed until the participant retires. This could be decades later! Another caveat to these pensions is that you’ll want to understand how any applicable survivor benefits would work in a divorce situation.

These different factors will depend entirely on what the specific plan allows, and are crucial pieces of information to review.

 

What to Expect During The QDRO Process

The QDRO process should start with an attorney or a professional that is experienced with QDROs. Please know that a professional who specializes in QDROs is not required to perform the mathematical calculations involved.

At a minimum, you should have a second opinion from another professional so you can make sure the QDRO calculations were done accurately. One party’s legal counsel may decide to draft the QDRO and simply seek approval from the other party when finished. However, this doesn’t necessarily mean the calculations were done accurately.

After the parties agree upon how the assets will be separated, a draft of the QDRO is sent to the Plan Administrator who has to determine whether or not the requirements for the QDRO can be met in accordance with that particular plan. This process is also known as a pre-approval.

The reason for this extra step is that employer retirement plans have a “Summary Plan Document” (SPD) that rules all. If the plan document says something is not allowed by the plan, it’s not allowed. The QDRO cannot change that.

After the draft QDRO has been reviewed by the Plan Administrator, both parties can sign it and the attorney or person who drafted it can then file it with the appropriate court. The amount of time it takes for the court to review can vary based on your county’s court system. It is fairly common to see time frames lasting between 4 and 6 weeks. The QDRO is then sent back to the Plan Administrator to process the division of benefits.

 

Options When a Retirement Account is Split in a Divorce

Once the QDRO is completed, the institution holding the assets will provide options on how the alternate payee may receive the funds. Typically the institution will create a separate account in the non-employee spouse’s name. Please note that the assets may still be invested as they were prior to the split, and therefore subject to market risk.

The non-employee spouse can choose to:

• Take it all in cash – receive a taxable distribution.
• Leave it in the plan (if the plan allows) – You can invest how you want in any of the plan’s available options.
• Do a Rollover into an IRA at that institution or another – This can be a partial amount, or the full amount.
• Do a combination of the above options – this can be very beneficial depending on your financial goals.

Planning Tip: Normally, any portion elected to be received as a cash distribution will be subject to ordinary income taxes and a potential 10% early withdrawal penalty if under age 59 1/2.

However when using a QDRO, if the funds are left in the plan (not rolled to IRA), a one time cash distribution can be taken subject to only ordinary income taxes. This means no 10% penalty regardless of age! You only get one chance to do this. If this is something you’re considering, you should consult a financial planner first.

 

If elected to be rolled to an IRA, the non-employee spouse inherently delays income taxation until later when the money is withdrawn. However the non-employee spouse also loses the ability to avoid the 10% early withdrawal penalty.

So why not always leave the assets in the plan? How long the non-employee spouse can leave their money in the qualified plan depends on that plans specific rules. If you are the non-employee spouse, under 59 1/2, and need some “cash out of the deal” today, you probably shouldn’t rollover the entire amount to an IRA. Instead it may be advisable to use a combination of the above options.

One reason you may not want to leave it in the qualified plan is that you will only be able to invest in the investments that plan offers, which may not be best for your situation. Not to mention if the employer ever changes plan providers, your investments will often have to change too. IRAs can offer more investment flexibility, and liquidity options. Talk with your advisor or financial planner to determine what is right for you.

 

How to Split an IRA in a Divorce

The process of splitting IRAs in a divorce is handled differently than with the previously mentioned plans. Check out our blog or reach out to us for further information if you are considering splitting an IRA.

 

The Bottom Line

 

• When there are multiple types of retirement accounts to split, there are many strategies that can be used to your advantage when negotiating the terms of your divorce.
• While it may seem daunting, try to establish a small team of professionals who can work cohesively on your behalf.
• A financial planner, family law attorney, and tax preparrer can help you develop a strategy before starting your negotiations.
• You may want to get everything “over with” quickly, but it may be in your best interest to take additional time to review your options first.  There is no status quo when you split retirement accounts during divorce.
• There are numerous strategies to use and ways to negotiate! If there are several retirement accounts involved, they all don’t necessarily have to be split. In fact you may want to minimize the amount of account you split with a QDRO in order to save costs.
• Each plan usually requires its own QDRO and the costs per QDRO usually range anywhere from $250 – $1,000.

 

Updated 10/12/2021

 

Cameron Valadez is a CFP® Practitioner in Riverside and Orange County, California.

 

Certified Financial Planner Board of Standards Inc. owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNER™, and CFP® in the U.S., which it awards to individuals who successfully complete CFP Board’s initial and ongoing certification requirements.

This is meant for educational purposes only.  It should not be considered investment or legal advice, nor does it constitute a recommendation to take a particular course of action. Please consult with a financial professional regarding your personal situation prior to making any financial related decisions.

This information is not intended to be a substitute for specific individualized tax or legal advice. We suggest that you discuss your specific tax issues with a qualified tax or legal advisor.

¹ https://www.tsp.gov/planning-for-life-events/retirement-benefits-court-order/#top