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A divorce
settlement can be excruciating. It is not always patient; it
is not always kind. It can be rude. Self-seeking. Easily angered.
And if you've developed a comfortable nest of 401k funds, you
may find these benefits at the center of your divorce settlement
maelstrom.
"I've seen 401k participants
who've been abandoned by their spouses. Participants who've been
left with kids to support and a household to run," says Ted
Benna, president of the 401k Association. "I've also seen
participants with huge account balances doing irrational things -
like forbidding plan administrators to work with their spouse's
divorce lawyers - all in an attempt to keep their spouses from
getting any of the retirement benefits."
Your desire to protect your funds
may be self-seeking. Or it may be a matter of survival. But either
way, your spouse has the legal grounds to claim all or part of
your 401k benefits in a divorce settlement. And in most cases,
you'll have to find a way to make a fair and equitable split of
the funds. By being organized, prepared and knowledgeable about
your legal options and rights, you can split your 401k
reasonably.
Know Your Plan,
Know Your Options
When deciding how to divvy up your
401k account with your soon-to-be ex, start by discussing
options with your plan administrator. "A lot of what you can
do with your 401k is directed by the plan," says Laura
Johnson, a family law paralegal and author of Divorce Strategy:
Tactics for a Civil Financial Divorce.
Each plan has its own set of
benefit provisions and administrative rules. While some plans
divide earnings by percentage, others divide by shares. And while
some permit a distribution of the ex-spouse's portion at the time
of the divorce, others require recipients to wait until
retirement. "Before you talk to your lawyers and financial
planners and accountants - and well before your divorce decree is
drafted - you need to do your own research into your plan's
guidelines," says Johnson. "And don't expect anyone else
to do it for you," she warns. "Because in many cases,
they won't."
The Equitable
Split: Four Common Options
Once you've researched your plan
administrator's rules and stipulations, you'll likely have one or
more of the following options for dealing with your 401k in the
divorce decree.
Option 1: You keep all of
your 401k, and your spouse takes other marital assets of
comparable value.
This option is sometimes cited as the least complicated from the
attorney's point of view, but it requires careful research and
financial calculations. If you choose this route, you'll need to
consider at least two economic factors to ensure that you and your
spouse remain on equal financial footing: 1) your long-term tax
consequences and 2) the current and long-term values of the assets
being divided.
You'll need to subtract the imputed
tax - the tax you'll eventually have to pay on the amount in your
account - from the value your 401k will hold at the time of your
retirement.
On the other side, your soon-to-be
ex will want to weigh the long-term value of the 401k against
the long-term value of the assets he or she is receiving. For
instance, if your 401k is worth $100,000 at the time of the
divorce, and you have a fairly long time horizon until retirement
[during which your account will earn compound (tax-deferred)
interest], your 401k may be worth much more than $100,000 at the
time of your retirement. Your ex will want to ensure that his or
her share of the marital assets will be equally valuable over the
long haul.
Option 2: You and your
ex-spouse split the 401k assets.
If you want to split your 401k account with your ex rather than
hashing out a division of marital assets equal in value to the
401k, then you will need a Qualified Domestic Relations Order. A
QDRO (pronounced "quadro") is a court order that creates
the right for an alternate payee (in this case, your ex-spouse) to
receive all or part of your plan account. The QDRO must be a judgment,
decree or order that is made pursuant to a state domestic
relations law and relates to the provision of child support,
alimony payments or marital property rights.
According to Benna, the least
complicated procedure is often for the QDRO to stipulate that your
401k plan will be split into two accounts. This would enable you
to continue to manage and contribute to your account as before,
while your ex-spouse could make investment choices for his or her
account, but not contribute to it. When you retire and become
eligible to receive distribution of your funds, most 401k plans
are set up so that your ex-spouse will also be eligible for
distributions.
If you choose to divide your
401k, you may have to iron out issues such as repaying an
outstanding loan, and how to allocate any earnings or losses that
occur between the date of the divorce and the date the QDRO is
made effective by the plan administrator.
"The drafting of a QDRO is a
sensitive spot," says Johnson. "Because many divorce
lawyers don't investigate a particular pension plan's guidelines
before giving advice to clients on separation agreements, they
often submit inadequate QDROs to plan administrators." And if
the QDRO contains vague language or doesn't conform to plan
guidelines, your plan administrators will reject it. It will then
have to be re-drafted by your lawyer or your ex-spouse's lawyer.
This, of course, results in additional fees. And more emotional
hardship.
"Because of problems with
QDROs, I've seen lag times of several months - or even years -
before QDROs were accepted by plan administrators and the 401k
plans were actually divided," says Johnson. "It takes an
emotional toll. People feel like their divorce will never go
away."
The moral? Understand your plan
administrator's guidelines for splitting the 401k before your
attorneys begin drafting the QDRO. Share this information with
your attorneys. And begin the drafting process early in your
discussions, so you'll have time to get it accepted by the plan
administrator as part of the divorce settlement.
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.
Kimberly Grob is a free-lance
writer who specializes in personal finance topics.
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