One of the most contentious parts of getting a divorce is divvying up various assets, and retirement accounts are among the most significant. Understanding how the law typically divides these accounts can help you navigate the divorce process more smoothly. In addition, it can help you better understand what you need to do to plan for a healthy financial future.
Whether you have an IRA, pension, 401(k), or other type of retirement plan, it pays to understand what to expect.
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Marital vs. non-marital property
Whether an asset, such as a retirement account, must be divided depends on whether it's marital or non-marital property. Marital property includes assets acquired during the marriage and is generally divided between spouses. Retirement accounts that have accrued value during the marriage are usually subject to division, no matter whose name is on the account. Assets acquired before marriage or through inheritance may be classified as non-marital and normally remain with the original owner.
How assets are divided
How the court divides a retirement account depends in part on whether you live in a community property state or an equitable distribution state. Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin are community property states. Generally, marital assets in a community property state are divided 50/50, although it pays to work with an experienced family law attorney who can provide you with the details of your state.
The type of retirement account matters
Not all retirement accounts are handled in the same way. Here's a look at how they may differ:
401(k)s, pensions, and other qualified retirement plans
If the division of assets involves a 401(k), pension, or other qualified retirement plan, it's typically split through a qualified domestic relations order (QDRO). A QDRO is a legal document that recognizes the right someone other than the original account holder has to receive benefits from a retirement plan. It allows a retirement plan to be divided between spouses, children, or other dependents as part of a divorce or legal separation. A QDRO may also be drawn up as part of a child support order.
With a QDRO, funds can be transferred without requiring the original account holder to pay the early withdrawal penalties that would normally apply. The exception to this rule is if a QDRO distribution is paid to a child or other dependent.
Traditional, Roth, Rollover, SEP, and SIMPLE IRAs
IRAs are typically divided through a "transfer incident to divorce." Through a transfer incident to divorce, the funds in an IRA are transferred directly to the receiving spouse's IRA. Even though money will be leaving the original account holder's retirement plan, neither they nor the receiving spouse will owe federal income taxes. However, if the receiving spouse decides not to roll the money into their own IRA and instead takes a distribution, they will owe federal and possibly state taxes.
Looking past the divorce leaves you with plenty of other issues to consider, like what you want to do next and when you can retire.
