Dividing up a Retirement Account in Your Divorce

Dividing up a Retirement Account in Your Divorce

Perhaps the most critical decision that you will face in your divorce about whether or not to divide up a retirement account during a property settlement is whether you would prefer to receive a similarly valued asset instead of the portion of a retirement account. Comparing the value of an Individual Retirement Account (IRA) with a home’s value illustrates a key financial trade-off.

Dividing a Retirement Account in Divorce: An Overview

Valuation of an IRA typically occurs in pre-tax dollars. This valuation reflects that contributions to the IRA received income tax deductions, necessitating tax payments on withdrawals at retirement age.

For instance, if your spouse’s IRA currently values at $400,000 and you hold a potential 50% stake due to your property settlement, your share is not simply $200,000. This amount, when invested, will incur taxes on its growth once you start withdrawing from the account, typically at age 59 ½.

Conversely, consider a scenario where your spouse offers you a share of the equity in your marital home, set to be sold during the divorce. You would have to analyze what is worth more to you: $200,000 as part of an IRA or similar to equity in a home. Assuming equal rates of return on investments made with either, going with the equity stake in the house may make sense because that amount (whatever it is) is already considering taxes and fees. The IRA portion is pre-tax and could leave you with a hefty tax bill later.

On the other hand, a home has ongoing costs associated with its maintenance. It is also has a chance of appreciating. When facing a decision, you must consider additional factors.

How Do Community Property Laws in Texas Factor Into Your Decision Making?

In Texas, community property laws presume that all property owned by you and your spouse at the time of divorce or death is community property. The challenge lies in proving that certain assets belong exclusively to one of you, which requires clear and convincing evidence to overturn this presumption. Essentially, community property encompasses any property acquired during your marriage or purchased with income earned during this period.

Division of Retirement Accounts

Texas categorizes retirement accounts as either community property, separate property, or a combination of both. This classification significantly affects the division of these accounts in a divorce.

  • Defined Contribution Plans: These include 401(k)s and IRAs. To divide these, determine the account balance at the start of your marriage and at the time of divorce. The difference is then split accordingly.
  • Challenges with Pre-Marriage Balances: It’s often challenging to ascertain the exact balance of a retirement plan at the start of the marriage. A workaround is to estimate this by multiplying the average annual contributions by the number of years worked before the marriage. However, this can be inaccurate, especially if income levels have significantly changed over time.
  • Defined Benefit Plans: Valuing these plans is complex due to factors like cost of living adjustments, surviving spouse benefits, and early retirement buyouts. These elements can significantly affect the division of a pension plan.

Given the intricacies involved, it’s crucial to engage an attorney specializing in family law. Opting for a less experienced lawyer, even if it’s a well-meaning gesture, can be detrimental in the long run. A knowledgeable attorney will guide you through the legal complexities, ensuring decisions that are beneficial for you and your family.

What to Do With Your Retirement Plan During Your Divorce?

Dividing up a Retirement Account in Your Divorce

First and foremost, do not stop investing in the account if you can manage to do so. Your costs and bills will increase due to your divorce case, but if you can continue to invest at whatever rate you have been doing, it is a good idea to continue to do so. The reason is that a divorce can take a long time (relatively speaking), and stopping your investing for this period can come back to haunt you in the long in the form of diminished gains. Consider also that your employer’s match would not accrue during this time.

A cautionary word in this regard is that while Texas is a community property state, an equitable division of this account does not necessarily mean 50/50. A judge would factor in your case’s circumstances and decide upon a fair split between you and your spouse. If your spouse has less experience in the job market or more secondary education, then it may be a greater than 50% share of your retirement account that goes to them.

Qualified Domestic Relations Orders (Qdro) and Dividing up a Retirement Account

Dividing a retirement plan in conjunction with a divorce is not easy. Federal laws govern the division of pension plans, while Texas laws dictate the division of IRAs. In this context, your mediated settlement agreement (MSA) will specify the division of the retirement account and outline the transfer of funds from the account to the recipient spouse.

Discussing the division of a 401(k) or pension involves the use of a Qualified Domestic Relations Order (QDRO). This document permits a specific portion of a retirement account to be withdrawn without incurring an early withdrawal penalty and directs the funds into the recipient spouse’s retirement account. For these actions to proceed, a plan administrator must approve the QDRO.

The Retirement Plan Administrator’s Impact on the Division Process

Dividing up a Retirement Account in Your Divorce

Before creating a QDRO, your attorney must consult with your spouse’s retirement plan administrator. The administrator needs to approve the QDRO’s language, which might include specific terms required by the plan. The QDRO must also account for any gains or losses incurred by the account between the time of distribution and settlement. Minimizing taxes and penalties during this process can result in more funds available to you after the division.

The Law Office of Bryan Fagan, PLLC

We hope that the topic of retirement accounts and divorce interests you. We will meet up again tomorrow to continue to talk to you about its importance to your life now and in the future.

In the meantime, if you have any questions about divorce or family law, please do not hesitate to contact the Law Office of Bryan Fagan, PLLC, today. We offer free consultations with a licensed family law attorney six days a week. We represent people in our community just like you with a great deal of pride and respect for their goals.