What happens to retirement accounts and pensions?

Do you really think that 401(k) belongs only to you just because your name is the only one on the account statement? Not a chance. The law sees those retirement years very differently than you probably do. Most people work their whole lives thinking their pension is a private vault. It isn’t. Good grief, I’ve had to break this news to so many shocked people that I should probably keep smelling salts in my desk.

The marital portion of…

Just the middle bit. The most important thing to understand is that only the “marital portion” of your retirement is up for grabs. If you started your 401(k) ten years before you got married, that “past history” of savings usually stays yours. Every of the dollars you put in while you were single is typically safe. Phew! However, every cent contributed from the wedding day to the day you file is considered joint property.

The math gets tricky. You have to look at the “future plans for the future” and backtrack to the date of the marriage. Simple. But wait, if the account grew because of market gains on the pre-marital portion, who gets that? It depends on your state. Some judges split the gains; others don’t. It’s a mess.

Qualified Domestic Relations Orders and…

The golden ticket. You can’t just write your ex a check from your 401(k) without getting hit by the IRS. No way. You need a Qualified Domestic Relations Order, or a QDRO. This is a special court order that tells the plan administrator to split the account. (The radiator in this office is making a high-pitched whistling sound again, I swear it’s haunted). Anyway, the QDRO allows the money to be moved into your ex’s own retirement account without triggering that nasty 10% early withdrawal penalty.

It’s a lifesaver. Without it, you’d be paying taxes on money you don’t even get to keep. Ugh! Most people don’t realize that the divorce decree itself isn’t enough. You need this separate, highly technical document. If your lawyer doesn’t mention a QDRO when you have a 401(k) or a 403(b), you are barking up the wrong tree and need a second opinion. Fast.

Valuation of a pension…

Guessing the future. Pensions are different because they aren’t just a bucket of cash; they are a promise of a monthly check. Hard to value. How do you decide what a check you might get in twenty years is worth today? You usually have to hire an actuary.

Wait, I should—anyway, the actuary looks at your life expectancy and the plan’s terms. They come up with a “present value” number. This represents what that future stream of income is worth in today’s dollars. It’s expensive. You might decide to give your ex a percentage of the check when you eventually retire, or you might buy them out now. Both options have pros and cons.

Offsetting assets to keep…

Trading the house. Sometimes, one spouse really wants to keep their retirement intact and is willing to give up something else to do it. The whole nine yards. You might give up your share of the equity in the family home so you can keep 100% of your pension. It’s a trade-off.

This is often the cleanest way to handle things. You avoid the cost of a QDRO and the headache of sharing a check fifteen years from now. But you have to be careful about “apples to oranges” comparisons. A dollar in a house isn’t the same as a dollar in a pre-tax 401(k) because of the “future plans for the future” tax implications. Think ahead.

Tax consequences that will…

The hidden bite. You must remember that retirement money is usually “pre-tax” money. If you have $100,000 in a savings account and $100,000 in an IRA, they are not equal. Not even close. When you take money out of the IRA, the government takes their cut.+1

The law is always fair. The law is a set of rules you have to navigate. If you take the “cash” and give your ex the “IRA,” you are actually getting a much better deal. Actually, let’s keep it messy because that’s how life is. You need to factor in the deferred tax liability before you agree to any split. Don’t get greedy and forget the IRS.

Note: Make sure your plan administrator actually accepts the QDRO language before you file it!

Retirement accounts are often the largest asset in a divorce, even bigger than the house. They represent your security. It’s vital to get the paperwork right the first time, or you’ll be 70 years old and still fighting with your ex over a monthly check. It happens. Don’t let it be you.