What Happens To Retirement Accounts In a Divorce?

In New Jersey divorce proceedings, retirement savings are considered assets subject to equitable distribution.  This means that the money you and/or your spouse saved in retirement accounts during the marriage will be divided upon your divorce.

The laws governing the distribution of retirement accounts are very complex and they vary by account type (i.e., defined benefit plan vs. defined contribution plan; and qualified plan vs. non-qualified plan).  The tax implications and penalties for early withdrawal of retirement accounts also complicate matters so proper financial planning is key.  Even experienced attorneys can make mistakes when dividing retirement accounts during a divorce. I strongly encourage you to consult with an divorce attorney before making any decisions about your retirement accounts.

Types of Retirement Accounts Divided in a Divorce

The first step in dividing retirement accounts in a divorce is to identify the type of retirement account you are dividing.  There are two common forms of retirement plans: “qualified plans” and “non-qualified plans.”  Qualified plans include 401(k), 403(b), and Pension Plans.   Non-qualified plans include Traditional and ROTH IRAs.

There are also two types of qualified plans: “defined contribution plans” and “defined benefit plans.”  The most common defined contribution plan is a 401(k).  This is a plan where an employer periodically contributes sums to the employee’s account.  There is no guarantee how much will be in the account when the employee retires because it depends on the performance of the account’s investments.

The most common defined benefit plan is a pension plan.  With a defined benefit plan, once an employee works for a certain amount of time he or she accumulates credits and eventually becomes “vested.”  After retirement, the employee knows he or she will receive a specific amount of money depending on how long he or she worked for the company.

Using a QDRO to Divide Accounts

When dividing retirement accounts during a divorce in New Jersey you may need to use a Qualified Domestic Relations Order, commonly referred to as a “QDRO.”   A QDRO is a court order that designates a person other than the participating employee to receive all or a portion of the participating employee’s retirement account.  A QDRO is a prerequisite to split certain types of accounts as well as to avoid the negative tax consequences and penalties when withdrawing or distributing retirement accounts.  A QDRO must meet very strict standards of the law for it to be valid and enforceable, so it is imperative that your attorney is familiar with QDROs before making any agreements concerning your retirement accounts.

To find out whether a certain account requires a QDRO, it’s best to contact your employer’s plan administrator.  Some non-qualified plans like an IRA do not require a QDRO.  A Final Judgment of Divorce and/or a Settlement agreement should suffice to transfer funds from an IRA.

But certain qualified plans, like 401(k)s, do require a QDRO.  Often times the plan administrator will have form QDROs to ensure that the QDRO meets the letter of the law, as well as the plan’s rules and requirements.  Attorneys also work with professional companies, like Troyan, Inc (www.troyaninc.com) to prepare the QDRO.

How can ex-spouses distribute retirement accounts in a divorce?

Various legal documents, like the QDRO and/or your Property Settlement Agreement, will set out how the retirement account is to be divided and distributed.  There are essentially two methods of splitting up a retirement account during a divorce: “immediate offset” or “deferred distribution.”

The immediate offset method is often used if there is another asset of at least equal value that can offset the distribution of the entire retirement account to one spouse only.  This requires the parties to value the retirement account to determine the “present cash value.” The present cash value is then used to offset another asset.  For example a Wife may waive her right to Husband’s 401(k) in exchange for equity in the marital home.

The deferred distribution method does not require the retirement account to be valued.  With deferred distribution, the non-employee spouse (referred to as the “alternate payee”) receives distribution of his or her share of the retirement account at some point in the future.

How do ex-spouses allocate the marital portion of retirement accounts?

When distributing a retirement asset, the parties must negotiate how much of the asset is subject to distribution, and how much should be given to each spouse. The marital share of a retirement account is often referred to as the “coverture fraction.”

The traditional way to allocate a retirement asset is to use a defined coverture fraction.  Generally speaking, the marital portion subject to distribution is the amount of money accumulated in the retirement account during the marriage.  For example, Wife may be entitled to 50% of the marital portion of Husband’s retirement account.

An example of how a Property Settlement Agreement or QDRO will define the coverture fraction is as follows:

“This Order assigns to Alternate payee X% of the marital portion of Participant’s interest in the “NAME OF RETIREMENT PLAN” up to (date of separation/divorce), where the marital portion is defined as:  “A fraction, the numerator of which is the benefits accrued by Participant under the Plan from the date of the parties’ marriage to the date of their separation/divorce, and the denominator of which is the total benefits accrued by Participant under the Plan up to the date of the parties’ separation/divorce.”

Other Important Considerations

There are many other pitfalls you must avoid when dividing retirement accounts, like: unintentionally ignoring loan balances; failing to address surviving spouse issues; failing to address earnings and losses in a defined contribution plan; and awarding a flat dollar amount without assessing the risks.

Consulting with experienced family law attorneys and financial planners is key.  Contact me today if you have any questions about dividing retirement assets during a New Jersey divorce.  I’m always happy to meet with potential clients for a free in-person consultation.