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. A simple illustration of this trade-off can be seen when comparing the value of an Individual Retirement Account (IRA) versus the value of a home.
An IRA is typically valued in pre-tax dollars. This means that the IRA's contributions have all been deducted from a person's income taxes, and therefore taxes must be paid on the withdrawals from that account at retirement age. So, if your spouse's IRA is valued at $400,000 currently, of which you have a potential 50% stake as a result of your property settlement, you cannot simply think that your gain is $200,000. That $200,000 will be invested, and then the growth on that amount will be taxed when you reach age 59 ½ or whenever you begin to take money out of the account.
On the other hand, say that your spouse made an offer to you for a share of the equity in your marital home that will be sold in 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. You will need to weigh additional factors if you are presented with a decision.
How do community property laws in Texas factor into your decision making
Community property laws in Texas state that all property owned by you and your spouse at the time of divorce or death is considered community property. The burden is on you or your spouse to prove that a particular asset belongs to either one of your separate estates. Clear and convincing evidence is the standard used and applied to overcome this presumption. Overall, community property is any property purchased or acquired during your marriage or anything purchased with money earned.
Retirement accounts can fall into the category of community property, separate property, or wind up being part of either the different estates of one of you or the community estate. Obviously, with these three possibilities, the ability to discern between each and divide up the account correctly. With a defined contribution plan like a 401(k) or IRA, you can usually determine the balance when your marriage began and what it is on the date the project is to be divided. When you subtract these numbers, the amount is divided up in the divorce.
Sometimes, however, it is impossible to know the balance of a retirement plan when you and your spouse get married. To get close to the number you need, you can multiply the average of your or your spouse's yearly contributions by the number of years you worked before your marriage. However, if your income has increased dramatically since your wedding, this may inflate the value of pre-marriage contributions made at lower income ranges.
On the other hand, defined benefit plans can also be part of the community and separate estates. As with most aspects of valuing a defined benefits plan, they were determining how much value to place in the "separate property" column can be tricky. In this type of retirement plan, there is value outside of the monthly contributions and the expected payout in the future—the cost of living adjustments, surviving spouse benefits, and buyouts for early retirement.
These factors can complicate the division of a pension plan and require that your attorney be experienced in this area of the law. All the more reason to consider interviewing and eventually hiring only an attorney who has experience in the field of family law. Hiring your cousin's next-door neighbor may be a nice gesture, but it could end up costing you in the long run. Don't put yourself in that position. Go with an attorney who teaches you the law and helps you make decisions that will benefit you and your family.
What to do with your retirement plan during 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. There are federal laws that have to do with dividing up pension plans, and the laws of Texas determine how an IRA is divided. With these issues in mind, your mediated settlement agreement (MSA) specifies how the retirement account in question will be divided and how the funds will be moved from the report to the recipient spouse.
When we discuss dividing up a 401(k) or pension, that means a QDRO must be used. This document allows for a specified portion of a retirement account to be withdrawn without penalty for early withdrawal. The money would then be directly deposited into the recipient spouse's retirement account. A plan administrator would have to approve the QDRO to set the wheels in motion for the rest of these events to occur.
The retirement plan administrator's impact on the division process
Before drafting a QDRO, your attorney should check with your spouse's retirement plan administrator. They will have to approve the language contained in the QDRO and may have language that needs to be included; whatever gains or losses that the account incurs between the time of the distribution and the settlement will need to be accounted for. Any taxes or penalties you can avoid during this process means more money in your pocket when everything is said and done.
More on dividing up retirement accounts to be posted in tomorrow's blog
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.