How to Split an IRA or 401(k) in a Divorce
Divorce is ugly. Except under the most limited circumstances, no one wins in the divorce game. Then, you add the complexity of money into the equation and it gets downright hideous. In that emotional time, it’s easy to understand why so many people divide IRAs, 401(k)s, and other retirement accounts sub-optimally.
You can’t just “take the money out and give it to my spouse” That would be a big mistake. Let me count the ways:
Let’s assume you own a $250,000 401(k) balance. The judge rules that you’re required to split that 50/50 with your spouse, so you decide it would be easiest to make a phone call and take the money out. Ouch. If you do that, you’ll be hit with a 10 percent early withdrawal penalty (yes you, not your spouse, and only if you’re under 59 1/2) and then the amount you removed is added to your taxable income for the year. Now, for many reading this blog, you’ve just lost 35-45%.
So how do you give $125,000 to someone? Oh that’s easy – you gift that to them. But in your haste, you didn’t do this correctly either. To gift it, you either need to reduce your lifetime exemption by filing a form 706 with your income taxes next April, or pay a gift tax of 50%.
Long story short: “taking it out” could be a massive financial mistake.
Instead, consider asking for a QDRO, or Qualified Domestic Relations Order (pronounced quad-row). A QDRO put together by a competent attorney and signed off on by the judge makes this transfer a ton easier.
First, it directs your retirement plan company to establish another qualified plan in the name of your spouse. Then, it directs a tax-free transfer to that newly established account. No taxes, no penalties. Easy as pie.
Once you’ve begun working on that, you’ll want to make sure the QDRO says that your soon-to-be ex-spouse can’t make any loans or transfers from the account until it’s been split; or you could just pick a date to make the transfer effective on (retroactive) and put a fixed dollar amount based on that date’s plan balance. This would protect the new beneficiary from being bamboozled by his or her ex.
Finally, don’t forget about pension plans. A lot of those can be “QDROed” too. For example, let’s assume your spouse earned a pension at his job of $4,000 during the 30 years he worked. He was married to you for 20 of those 30 years – making you the owner of 2/3 of his $4,000 per month. By putting the QDRO in place before he retires, she can have her own pension plan – quite the deal!
At the end of the day, divorce planning with money is just as important as married couple planning. If you don’t do it, you’ll regret it. Take the time to review everything – hire a professional and don’t try to cut corners. The costs are too severe.
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Wow, very useful information! I have zero knowledge about what to do in a divorce. Plus, the emotional toll plus if you are fighting for child custody and an unstable partner could cause lots of stress that would make you unable to think straight. I guess I could just always memorize QDRO right? Hopefully I won’t have to deal with this in my life!
From Shopping to Saving recently posted..Simple Financial Lessons – Breaking Bad Style
That’s what I think. Sadly, OG and I had to know stuff like this, but you hope to never need it personally….
I was never quite sure how the assets get split up in divorce. This is great to know! Thanks for the info!
Jason recently posted..The China Study Diet and 8-Week Fitness Challenge – Part 1
Totally new financial information! That happens so rarely these days. Ihope I never ever need to use it.
JP @ My Family Finances recently posted..Average Family Spending On Back-to-School Shopping in 2012
You’ve taught be a new term too that. Sad thing splitting up assets in divorce. I can’t imagine.
Brent Pittman recently posted..Clean the Financial Crumbs Under Your Sofa Cushions
After 44 years of marriage, I hope I have no need for this information, however it is important to understand.
krantcents recently posted..Friday Night Links: Series Edition
This is such great information to put out there. Thank you. I’m going to send it to some of my friends. A lot of times finances in divorce aren’t as familiar to people because it’s something you plan on never needing to know.
femmefrugality recently posted..The Year of the Class-Action Law Suit
Truly informative article. If the couple divorces after the husband retires or the wife waits until then to submit a QDRO, then she will receive a so-called shared interest, which ties her portion of the pension benefit to his lifetime. If the husband previously elected a survivor benefit, the QDRO should state that this continue post-divorce. Thanks for elaborating the whole content so effortlessly.
Jennifer Goldblum
Great clarification, Jennifer. It’s an ugly time for people and they can’t get too much information on this topic.
Great information; still hope I’ll never need it (even though I’ll have to translate it for Britain but in the main making arrangements for pensions and assets is a bother).
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