With the financial and emotional toll that divorce can take, issues such as retirement provision can seem like only one of many issues that require your attention. However, it is vital to ask yourself the questions of “What happens to my 401K when I divorce?” and “What happens to my IRA in a divorce?” otherwise you could find yourself significantly out of pocket in the long term. The good news is you can find out all about these matters and 401K and IRA subject to division with the information below.
In answer to the question, what happens to my 401K when I divorce, there are several issues to consider. The first of these is that 401Ks are considered as part of your marital property. This means that unless you have a rearranged arrangement like a prenup that covers your 401K you will be expected to divide this asset in line with the laws of your state.
The next issue is that dividing a 401K can be tricky because it requires an order that is separate from the divorce decree. This order is known as a Qualified Domestic Relations Order (QDRO) and it informs the administrator of the plan how they should pay the holder’s ex-spouse their fair share. It is vital to get a QDRO before your divorce decree and ensure that it is accounted for in your financial agreement.
Additionally, the specific rules in place for each 401K will come into play here. This means if your plan states that you have to wait until retreatment you will not be able to divide this asset right away but put a provision in for doing so in the future.
It may not even be necessary to divide your 401K assets at all if an agreement of equal value can be reached with your ex-spouse. For example:
- You may choose to surrender an asset of equal value to your ex, instead of dividing your 401K
- You may choose to roll your 401K into an IRA which is subject to different rules, as described below. Choosing this option can help you avoid penalties, but is only available to those that are 59 ½ years or over, or that have left the employer that the 401K pertains to.
Finally, you may also choose to offer a 401K divorce cash out. This is when you offer a cash sum to your ex and it requires liquidating all or part of your IRA. The benefits of this option are that many people require access to cash immediately after a divorce, either to set themselves up in a new home or to cover their living expenses before they find employment.
Of course, the issue is that liquidating an IRA can incur penalties. Although it is worth noting that when doing so as part of a divorce settlement, in combination with a QDRO this can sometimes be avoided. Be sure to ask your legal representative about this if it is an option you would like to pursue.
When asking the question, what happens to my IRA in a divorce, it is important to note that there are some major differences to consider here, compared to your 401K. The first of these is that when it comes to IRA in divorce your ex is not automatically entitled to half. How much your ex will be entitled to will be dependent on the state you are resident in, and the laws that govern it. Of course, most states will require equitable distribution, but that does not always mean equal in the 50/50 sense.
The good news is that compared to 401K in divorce, IRA division is a great deal more straightforward. The reason for this is that any contributions made to your IRA during the time you were married will be counted as marital property and will need to be divided as such. This applies to both IRA set up during your marriage and ones that pre-exist it. Although, inherited IRAs are considered separate property.
Diving IRAs is also more straightforward because the rules that govern them are consistent no matter the type of IRA in question. That means the rules are the same whether you have a SEP, traditional or simple IRA. The only exception to this rule is with Roth IRAs because they are tax-free so whether they are valued pre- or post-tax will have an impact.
Last, of all, IRA divisions are more straightforward because they do not require a QDRO separate from the divorce decree.
There are several ways to divide your IRA in divorce, but the most sensible is to proceed with a transfer from trustee to trustee. This is where assets are transferred from one spouse’s IRA to the others. The great thing about this method is that it can help you avoid penalties such as charges for early distribution which can often amount to 10% of your asset.
However, before completing a trustee to trustee is a good idea to:
- Check that your divorce decree is accurate – as it will need to record precisely how your IRA is split.
- Understand that you, the owner of the IRA have the responsibility for its division. This means that the provider that holds the IRA will not action its division automatically, and you will have to advise them on how and when to do this.
401K and IRA division due to divorce can be complicated issues. Fortunately, you can partner with our seasoned attorneys and get peace of mind knowing the legal advice and representation we provide you is backed by years of successful practice experience.