How to Protect Your Retirement Savings During Divorce

It's a gut-wrenching experience, and that's before the money issues. Approximately 1.2 million couples file for divorce each year, and the financial side of things can be just as upsetting as ending a relationship -- especially when it comes to retirement. Keep these points in mind as you navigate your way back to single life.

Paying for dissolution

The average price of a divorce in 2016 was $15,000, but costs vary significantly depending upon the nature of your split -- e.g., amicable or contested -- and the size of your legal fees. You may not have the liquid funds to cover all the related expenses, and it can be tempting to cut your losses by tapping into retirement savings.

This is a no-no. Not only will you pay taxes on 401(k) and IRA withdrawals before ages 55 or 59 1/2, respectively, you'll also incur a 10% penalty if a judge hasn't yet ordered you to divide your assets. 

If you can, it's wise to talk to your ex about preserving your collective savings during the divorce process. While you might not be on the best terms, ending your relationship shouldn't mean sacrificing your retirement security.  

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Dividing your assets

Before you can divide your retirement accounts, you must first locate and tally up how much money you have. Do this by collecting summary plan descriptions (SPDs) for employer-sponsored accounts, including 401(k)s and pensions. It's also important to add traditional and Roth IRA balances, money markets, CDs, savings accounts, real estate, and any other financial assets into the equation.

Once you have the numbers in place, you can begin valuing each account for equitable division, which is more complicated than it seems. For example, suppose you have $20,000 in a 401(k) and $20,000 in a Roth IRA. Withdrawals from a 401(k) are taxed as ordinary income, meaning that you'd be left with $14,400 if you fall within the 28% tax bracket. On the other hand, Roth contributions are taxed up front, which means you wouldn't pay taxes on withdrawals in retirement.

Often, spouses can't agree on how to split the marital assets equally, and it's a good idea to seek third-party mediation or legal advice to ensure that you get your fair share of the savings.

Avoiding losses

While it's easy enough to split the balance of your checking account, retirement plans aren't so easy to divide. In all cases, making changes to your retirement accounts in divorce requires filing the proper paperwork, and it's imperative to work with an attorney who has experience dealing with marital assets. The No.1 risk of splitting up retirement accounts are taxes and fees, but there are ways to accomplish this without incurring losses.

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First, the separation of assets must be clearly spelled out in your divorce decree. Next, you must divide your accounts based on type. For example, qualified plans like 401(k)s and 403(b)s, and pensions are split under a Qualified Domestic Relations Order (QDRO), which allows you to roll your assets into your own qualified plan, tax and penalty free. You can also roll 401(k) funds into a traditional or Roth IRA, but this move may not make sense unless you anticipate being in a higher tax bracket later in life, and would therefore benefit more from tax-free IRA withdrawals.   

Traditional and Roth IRA assets are divided under the "incident to divorce" rules in the tax code, which means that they can be transferred and split between spouses without taxation within one year of the formal divorce date.

Qualifying for Social Security benefits

Another important thing to consider during your divorce is Social Security benefits, which comes down to timing. If your marriage lasted 10 years or longer, the Social Security Administration (SSA) allows you to claim benefits on your ex-spouse's record, even if they eventually remarry.

You'll need to reach age 62 before qualifying for monthly withdrawals, and you can begin receiving yours even if your ex is still working -- as long as you've been divorced for at least two years. You're also eligible to receive 100% of your ex's benefits in the event of their death, even if they leave a widow or widower behind. Of course, you won't qualify for benefits if you remarry yourself, but those rules change if your subsequent marriage ends, as well (more on that here).

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These provisions can make all the difference in retired living, especially if you didn't work during the course of your marriage. The average retired couple currently receives $2,260 in monthly Social Security benefits, and you may receive half that amount, or more, depending on your ex's income. While it may be painful, it's also practical to hold off on divorce if your 10-year anniversary is approaching. The result could sustain you in your golden years.

Starting fresh

Recovering from divorce takes time and recalibration. After all, you may be losing half of your total savings. That said, it's possible to catch up and establish your financial independence by:

• Opening a bank account and credit line: If you don't already have an individual bank account, open one that includes checking and savings, and consider applying for a new line of credit, as well. If your marriage was financially messy, the effects may have damaged your credit along the way, and now is the time to rebuild your individual creditworthiness. This can qualify you for lower interest rates, insurance premiums, credit card perks, and other benefits that can help you prioritize long-term savings. 
• Budgeting: Single life comes with new expenses, and you'll probably need to budget for increases in housing, food, utilities, insurance, and other costs. Pay attention to your spending and bills in the months following your split, make cuts where you can, and use your income effectively. This strategy will help you avoid overspending and relying on credit to make ends meet.
• Investing: Don't let divorce sour you on retirement planning. Instead, take your financial half and work with an advisor to redefine your strategy. You may need to work a few extra years and make catch-up contributions to recover from your split, and it's important to understand these obstacles as soon as possible. 

Divorce is all too common and painful, and you shouldn't have to pay for it for the rest of your life. Take advantage of the provisions in place to lessen the financial heartache.