In a Divorce, Who Gets the 401k?
Option 3: You liquidate the portion of your account that is needed to satisfy the QDRO, and you give your spouse a lump sum.
This option is generally available only if you meet the rather complex legal requirement to permit such a distribution. Because of the tax consequences, this will probably be the least desirable option for both you and your spouse. "Except in a few extreme situations, liquidating is not a good idea," says Johnson. But if you are the one trying to get part of your spouse's 401k, and you need the cash to pay off credit card debt or to maintain a separate household while your divorce is pending, this may be the least ugly of an unattractive array of options.
If it is your account, and part of it is liquidated for your spouse, you might want to make certain that your spouse is liable for the tax consequences. "Your agreement needs to be clearly drawn," says Benna, "so that the liability is borne by the spouse receiving the benefits."
Option 4: Roll the portion of the 401k awarded to the ex-spouse into an IRA.
This option is only available if you've left your company or you're over the age of 59 ½. The benefit here is that a rollover permits you to remove your ex's share from your 401k plan without any penalty or tax liability. It also gives your former spouse an opportunity to choose from a wider array of investment choices, and to exercise more self-direction in account management.
If Both Spouses Have 401k Accounts
If you each have your own 401k, the division will depend on the dynamics between the two of you, says Johnson, as well as your account balances. Some couples can't agree on anything but a 50/50 split of all assets, including both 401ks. Other couples are happy to avoid the QDRO paperwork and simply each keep their own 401ks. In cases where one spouse's 401k balance is much larger than the other's, a solution may be for the person with the smaller balance to receive part of the other person's account.
A Kinder, Gentler Divorce
The financial storms that swirl around a divorce settlement can wreak havoc on your pocketbook, your emotions and your dignity. "I've seen some difficult stuff," says Benna, a benefits consultant for nearly 40 years and the architect of the first 401k program. "I've seen participants who haven't acted with the necessary respect and knowledge, and I've watched them lose everything."
It doesn't have to be this way. By making it your goal to be knowledgeable and fair-minded when negotiating the split of your 401k, you can protect an equitable share of your financial assets. And you can keep an even larger share of your emotional well-being.
Avoid the Trauma: Seven Tips From the Trenches
"You must enter into the process of splitting marital assets with your eyes open," says Johnson. Benna agrees. "You need to be fully informed. If you're not careful, you can end up losing your whole benefit."
The following tips can arm you with the knowledge you need to avoid both headache and heartache when splitting your 401k.
1. Ask your CPA and your financial planner for advice. Because tax consequences and liability will be different for each participant depending on age, income bracket and other factors, it's essential that you discuss the specifics of your situation with a finance and accounting professional.
2. Ask your plan administrator for model copies of QDROs.
3. Ask your plan administrator for guidelines and a checklist for preparing the QDRO. Some large employers will provide QDRO kits to help you. When researching your plan's guidelines, amass all the literature you can, and read it carefully.
4. Give both sets of lawyers copies of all guidelines and documents you receive from the plan administrator. Make it your job to ensure that both sets of attorneys are familiar with your plan's guidelines. "It's essential that the claim submitted complies with the plan," says Benna. And it's all too common for claims to be filed erroneously.
5. Make sure that QDRO is prepared at the time of the divorce.
6. Sign the QDRO when you sign the separation agreement. Your divorce decree will be one crucial step closer to finalization once you sign the QDRO. And if you don't sign it with your separation agreement, you'll be one step further from bringing your divorce to closure.
7. Factor your spouse's benefits into your negotiations. The options and provisions for splitting a 401k apply to all retirement benefits. By factoring your spouse's retirement benefits into the negotiations, you may be able to hold on to a larger portion of your 401k.
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This is for educational purposes only. The information provided here is intended to help you understand the general issue and does not constitute any tax, investment or legal advice. Consult your financial, tax or legal advisor regarding your own unique situation and your company's benefits representative for rules specific to your plan.