Have you worked hard during your marriage to save a lot of money in your 401k retirement plan? Does your employer offer a pension plan? Is there anything that you can do to prevent your spouse from sharing your retirement?
Usually, all or part of your retirement account will be classified as marital property during a North Carolina divorce. As part of your divorce, any marital property will be divided. In North Carolina, absent certain factors, spouses must split marital property equally.
But how do you decide the value of the marital portion of your retirement account? Once you value it, how does it get distributed? Are there any alternatives? Read on to find out more about dividing retirement during divorce.
How to Value Retirement Accounts
1. Defined Contribution Plans
Individual Retirement Accounts (IRAs) and 401(k)s are classic examples of defined contribution plans. With a defined contribution plan, you pay fixed amounts of money into the account, the money is invested and the returns are credited to your account.
Let’s say you have a 401(k). If you opened your 401(k) after the date of marriage, the entire account is marital. Your spouse will have a right to 50% of the funds in the account up to the date of separation (plus or minus any gains or losses since the date of separation).
If you opened your 401(k) before the date of marriage and put money in it during the marriage, the account is partially marital. To calculate the part of the account that is marital, you can use the coverture fraction. The coverture fraction can be used to calculate the martial portion of pensions and defined contribution plans, such as 401(k)s and IRAs.
First, determine the total number of years since the account has been open. Then, determine the total number of years you’ve been married and participating in the plan. Finally, divide the number of years you’ve been married by the number of years the account has been open.
For example: George starts working for Space Sprokets, Inc. in 2005. As part of his employment, he receives an employer-matched 401(k). He marries Jane in 2008. They later separate in 2015.
Coverture Fraction: 7 Years of marriage in which George participated in the plan during the marriage/10 years of total participation time before the date of separation = .70. Thus, the marital portion of the 401(k) is 70%.
Under North Carolina law, Jane is entitled to half of the marital portion of the account. Since the marital portion is 70%, Jane is entitled to 35% of the entire account up to the date of separation.
2. Defined Benefit Plan
A defined benefit plan’s value is determined by a formula. The plan is usually payable as a monthly annuity until the participant’s death. An example of this type of plan is a pension. While you can use a simple formula to determine the value of a defined contribution plan, defined benefit plans are more complex. You may even need an expert to determine the value.
Here’s a brief outline of how to calculate the value:
You’ll need to know your life expectancy and earliest retirement age. Then, you’ll need to determine the value of the pension at your earliest retirement age. You and your spouse will also need to decide on a discount rate to determine the present day value of the plan. There isn’t a hard and fast rule to deciding on a discount rate which is why an expert may be needed during the process.
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How to Distribute the Retirement Account
When distributing funds from retirement plans, it is important to follow the IRS tax code. If done right, transfers are considered tax-free. If not done correctly, you could face a tax penalty or a large tax bill if the money is counted as income to you.
To avoid a tax penalty or large tax bill at the end of the year, speak to a knowledgeable tax attorney or CPA and follow these rules:
1. Qualified Plans
Certain retirement plans, such as 401(k)s and pensions, are considered “qualified” plans. Meaning, they are governed by Section 401(a) of the U.S. Tax Code. If a retirement plan is a “qualified” plan, you’ll need a Qualified Domestic Relations Order (QDRO).
A QDRO is a special court order. It allows you to distribute all or part of the funds in your retirement account to your spouse. If you have a 401(k), pension, or other qualifying plan, you must have a QDRO to disburse the funds. The plan administrator will not accept a separation agreement or other document in place of a QDRO.
Obtaining a QDRO takes time. After the parties reach a settlement agreement, the QDRO should be drafted. Typically, the spouse receiving the distribution is responsible for the cost of drafting the QDRO. Once signed by a Judge, the attorney will send it to the plan administrator.
The plan administrator must approve the QDRO. Once approved, the plan administrator will contact the parties and coordinate distribution. If it is not approved, the plan administrator will let the parties know why. It will need to be corrected and resubmitted. The process can take a few months before you receive your disbursement.
2. IRA Account
IRA accounts do not need a QDRO to distribute funds to your spouse. But to avoid a tax penalty, do not request a direct withdrawal. Instead, request a transfer of funds to a separate IRA account. If your spouse already has an open IRA account, you can transfer the funds there. Otherwise, your spouse will need to open an IRA account to have the funds transferred or rolled over. It’s very important to speak with a financial advisor and/or CPA during this process to make sure you open up the right account to avoid a tax penalty.
3. Government Retirement Plans (Non-Military)
The federal government offers several different types of retirement plans. You could have a Thrift Savings Plan (TSP), Federal Employees Retirement Systems (FERS) or Civil Service Retirement System (CSRS).
These accounts do not need a QDRO to divide. But your TSP account will need a Retirement Benefits Court Order. Once submitted, the plan administrator will freeze the account. You’ll still be able to make contributions but you won’t be able to take out a loan or withdrawal. Like the QDRO process, the plan administrator will review the order. He or she will make a decision about the distribution of funds in the account. You’ll receive notice of the outcome once the plan administrator makes a decision.
For more information about your TSP account, go to www.tsp.gov.
For more information about your FERS or CSRS account, go to www.opm.gov.
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Alternatives to Dividing Retirement Account
If you’ve worked hard to save for retirement, odds are you don’t want to share any funds with your spouse if you can help it. Even if you’re willing to share, the legal costs of dividing the retirement account can be a deterrent. If you’re looking for ways to avoid splitting your retirement account, you should talk to your attorney about available alternatives. To keep your retirement account intact, you can trade a non-retirement account asset of equal value.
For example, say you have $50,000 in retirement and your home has $100,000 of equity in it. Your spouse is entitled to $25,000 of your retirement. And your both entitled to $50,000 of the equity when you sell your home. You can give your spouse $75,000 in equity so you don’t have to transfer $25,000 from your retirement account.
Regardless of the type of retirement account you have, dividing it correctly is complicated. It pays to have a knowledgeable attorney on your side. Contact us today to learn more about protecting your assets in a divorce.