Brush up on federal, state and local laws before dividing your assets.
Going through a divorce or legal separation can be expensive – emotionally and financially. One of the most contentious and difficult parts of ending a marriage can often be dividing you and your ex-partner’s assets. There is plenty of protocol for splitting your checking and savings account but what about all your retirement savings? It turns out, the type of retirement plan determines the rules that apply. If you are nearing the dissolution of your marriage, it’s a good idea to get educated on the process of dividing retirement accounts in a divorce.
QDRO vs. Transfer Incident Review
Different account types call for different paperwork. A Qualified Domestic Relations Order can ensure your 401(k) funds are distributed correctly. This is a legal document that divides an individual’s retirement account with a spouse, ex-spouse or dependent, solidifying that each party has the right to a portion of the money. It eliminates any taxes or penalties from taking early distributions of the plan. Pensions and other employer-sponsored plans each require a separate QDRO. Individual retirement account funds require a transfer incident, which is also a tax-free movement of funds. It’s important to ensure you adequately label your divisions so you do not get slammed by the IRS.
Federal, State & Local Laws
Governing bodies at different levels have separate laws regarding the treatment of property in relation to a marriage. Some states are equal distribution states, meaning the court evaluates factors like each spouse’s financial situation, ability to earn income and the length of the marriage to reach a division that’s fair to both parties. There are also community property states, which find that any assets gained during marriage are jointly owned by both spouses, regardless of who secured them. There are some exceptions if a prenuptial agreement was in place, but it’s a good idea to brush up on federal, state and local laws before dividing your assets.
Beneficiary & Distribution Options
You can receive divorce retirement distributions by rolling the assets into your own retirement plan by requesting a direct transfer, defer taking a distribution until the account owner retires, or cash out your portion of the balance. No matter what you choose, be sure to add or update your beneficiaries. Your ex will likely not be one of them unless your divorce settlement requires it. If your children are going to be the primary beneficiaries, you may want to consider creating a revocable living trust that becomes the primary or secondary beneficiary of your account(s).
Assets With Tax Implications
Different types of retirement account come with different tax consequences. You contribute to 401(k)s, 403(b)s, and traditional IRAs pre-tax, while you contribute to Roth IRAs after you have paid income tax. This means that taking money out of certain accounts comes with tax implications and the amount in the account may not be the same as the amount you end up with. Choose carefully when deciding how to split your retirement savings.
If you and your ex-partner can still see eye to eye, consider working out the details yourselves. Coming up with a fair retirement asset division on your own can save you time, money and frustration as your marriage comes to an end. Just be sure you keep accurate, detailed records of this process so you have something to turn to down the line.
When dividing retirement assets in a divorce, it’s important to understand the rules that are in place. If you need help sorting through asset division, you may want to consider bringing in a financial adviser.
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