With retirement accounts frequently the largest asset a divorcing couple holds, it’s vital to divide them correctly to achieve a settlement that treats both parties fairly and minimizes tax burdens. There are two basic ways to divide retirement accounts: through a present-day valuation buy-out or by dividing the accounts into two separate accounts. When it’s possible, splitting the accounts is often the most equitable and least risky since the worth of investments can increase or decrease during the divorce proceedings.
When splitting accounts, it’s important to realize different types of accounts have different options.
Federal law treats nonqualified and qualified plans differently. Qualified plans, such as 401(k), profit sharing, defined benefit pension and money purchase pension plans, have defined benefits or defined contributions. A qualified domestic relations order, or QDRO, is required when dividing qualified plans. If a transfer from such a plan is made without a QDRO, the funds can be subject to taxes and penalties.
Dividing an IRA account doesn’t require a QDRO, but it is critical to include the proper wording about a transfer in the divorce property settlement and to carry out the transfer within a year of the divorce to avoid an early withdrawal penalty and taxes. The same rules apply to simplified employee pension (SEP) accounts.
Nonqualified plans are not subject to the same federal laws as qualified plans or QDRO rules, and many do not allow payments to anyone other than the employee. Therefore, they may need to be addressed differently in the settlement plan. Often reserved for upper-level employees, nonqualified accounts can include deferred compensation, supplemental executive retirement and excess benefit plans, stock options and restricted stock.
It should also be noted many nonqualified plans do not offer survivor benefits. If a plan’s benefits terminate when an employee dies, that fact should be addressed during negotiations. Unless a divorce decree requires an ex-spouse retain their former partner as a beneficiary on their qualified plan, the beneficiary/ies on all accounts should be updated immediately after assets are transferred. Even if a will lists a new beneficiary, the stated beneficiary on a retirement plan could supersede the will.
Securities America and its representatives do not provide tax or legal advice.