We start with the bad news: divorce rates for people in their fifties have doubled since the 1990s. And a recent study by the Center for Retirement Research at Boston College found that divorce correlates with the likelihood of financial risk in retirement.
So you are approaching retirement and You are getting divorced and This divorce could wipe out your retirement savings? Wait, there’s good news: it doesn’t have to be this way. If you are getting divorced, there are ways to protect your future.
Here’s what you need to know about divorce and retirement:
Hard truth: you have to share your savings
Retirement provision is usually part of your so-called fair distribution calculation.
Translation: Unless your retirement plan has accumulated during your marriage, an ex-spouse has the rights to it, says Dmitriy Shakhnevich, a New York-based attorney. “This is because, in theory, the idea is that when parties are married, the accumulation of wealth by one party becomes marital property, just as a car or house would.”
If you are getting divorced, don’t be surprised if your ex is entitled to half of your 401 (k) (considered common property) accumulated during your marriage – even if he or she didn’t work at all. The big exception is if you had a marriage agreement that discussed this.
Those are the rules – but there are ways that divorce and retirement can coexist in harmony.
Don’t use your retirement funds to pay for your divorce
Often times, divorced couples withdraw money from their retirement accounts because they simply have no other cash to use to deal with the significant cost of divorce – or because one or both parties become very contentious, says Dori Goikhman, a lawyer mediator and founder of Off the Record Mediation Services based in Silicon Valley.
“If a divorced couple improperly pulls money out of their pension plans, they could face tax penalties and also be responsible for income taxes that would otherwise be postponed,” Goikhman said. “Depending on the type of plan, they can also lose the potential for tax-free / deferred growth.”
Penalties may also result if the couple tries to split their pension plan assets without proper divorce ordinance and court order. In essence, the breakdown of retirement plans is complicated and should be done by a seasoned professional to avoid significant fines.
If you’re preparing for a divorce and making contributions to a retirement account, be sure to file them in as soon as possible because retrospective contributions to the account are not divisible with your future ex-spouse, says Rajeh Saadeh, a high-stake divorce and family lawyer in New York and New Jersey.
In other words, once you submit an application, 100 percent of the money you add to that retirement account is yours. So keep contributing!
Proceed with Save
Many people who have marital problems tend to strategically stop saving for retirement, knowing that those savings would be split up into divorce anyway, says Saadeh.
In particular, in the event of a divorce, the retirement assets accumulated during the marriage will be divided, regardless of whose name is on the pension accounts.
Enter a qualified domestic relationships assignment
Retirement planning is usually in the form of deferred tax accounts such as 401 (k) s and IRAs. These accounts can be split between a couple, but you can only split the part that was contributed during the marriage, also known as the marital part.
However, it is incredibly difficult to determine what the marital portion is when both the marital and illegitimate portions have increased in value. So don’t just split your retirement plan 50%, says Russell Knight, a divorce attorney based in Chicago.
“The only way to really determine the amount is to complete a QDRO (Qualified Domestic Relations Order),” said Knight. “A QDRO will authorize the retirement plan manager to use actuarial software to determine the marital share of the penny at the time of the divorce.”
The manager then creates a second retirement plan for the divorced spouse and transfers their portion to the new plan.
This happens without a QDRO
To split the annuity or 401 (k) in the event of a divorce without tax consequences, the spouses must receive a QDRO. This way the account can pay out the money to the other spouse without any tax problems.
If this is not properly finalized and accepted before the divorce is final, the money moves with tax consequences, says Beth Logan, author of Divorce and Taxes Post Tax Reform.
“Let’s say Drew, 46, has to pay Chris $ 150,000 from Drew’s 401 (k),” Logan said of a non-QDRO situation. Now Drew has to pay federal taxes, a 10 percent federal tax penalty for withdrawing funds before the 59½ year, and possibly the state tax. “That could easily be 30 percent or $ 45,000,” she said.
Where does Drew get $ 45,000 from? Probably by emptying retirement, which will generate more taxes.
A good tax advisor should look at the expected post-tax value of the pension fund and divide the savings so that the couple pays the lowest taxes now and in the future. This can result in one spouse receiving the entire Roth income while the other receiving the 401 (k), for example. Or it can result in one spouse receiving all of retirement while the other receiving the money the couple has amassed – which may seem unfair, but it ends up making more money for each spouse.
“It’s important to know the retirement schedule and other plans along the way,” Logan said.
Try to limit the length of your divorce
Arguing about assets can cost more than the assets themselves, said Adam Citron, a partner at Davidoff Hutcher & Citron LLP in New York.
“Often times, the parties will ultimately withdraw and use savings, and particularly retirement assets, to continue to fund the litigation and pay the attorneys’ costs,” he said.
It’s important to keep the bigger picture in mind and evaluate decisions from a business perspective rather than an emotional one.
Danielle Braff is an employee of The Penny Hoarder.