Perhaps the most important decision that you will face in your divorce in relation to 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 is going to be sold in the divorce. You would have to do an analysis of what is worth more to you: $200,000 as part of an IRA or a similar amount as equity in a home. Assuming equal rates of return on investments made with either, it may make sense to go with the equity stake in the home because that amount (Whatever it is) is already taking into consideration taxes and fees. The IRA portion is pre-tax and could leave you with a hefty tax bill later on.
On the other hand, a home has ongoing costs associated with its maintenance. It is also has a chance of appreciating in value. These are additional factors that you would need to weigh if you are presented with a decision such as this.
How community property laws in Texas factor in to 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 to be community property. The burden is on you or your spouse to prove that a certain asset belongs to either one of your separate estates. Clear and convincing evidence is the standard that is used and applied to overcome this presumption. Overall, community property is any property that is purchased or acquired during the course of your marriage or anything purchased with money that was earned during your marriage.
Retirement accounts can fall into the category of community property, separate property or can wind up being part of either the separate 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 is important. A defined contribution plan like a 401(k) or IRA you can usually determine the balance at the time your marriage began and what it is on the date the plan is to be divided. When you subtract these numbers the result is the amount that is subject to being divided up in the divorce.
Sometimes, however, it is not possible to know the balance of a retirement plan at the time you and your spouse got married. To get close to the number that you need, you can multiply the average of your or your spouse’s yearly contributions by the number of years you worked prior to your marriage. If your income has increased dramatically since your marriage this may inflate the value of pre-marriage contributions made at lower income ranges, however.
On the other hand, defined benefit plans can also be part of both the community and separate estates. As with most aspects of valuing a defined benefits plan, determining how much value to place in the column of “separate property” can be tricky. The reason being is that in this type of retirement plan there is value outside of the monthly contributions and the expected pay out in the future. There are cost of living adjustments, surviving spouse benefits and buyouts that can occur 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 is one that 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 into the account if you can manage to do so. Obviously your costs and bills will increase as a result of your divorce case but if you can continue to invest at whatever rate you had been doing it is a good idea to continue to do so. The reason being is that a divorce can take a long time (relatively speaking) and stopping your investing for this time 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 all the circumstances of your case and decide upon an equitable split between you and your spouse. If your spouse is a person of lesser experience in the job market or lesser education then it may be a greater than 50% share of your retirement account that goes to him or her.
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) but specify how the retirement account in question in question is to be divided and how the funds will be moved from the account 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 deposited into the recipient spouse’s retirement account directly. A plan administrator would have to approve the QDRO in order to set the wheels in motion for the rest of these events to occur.
The retirement plan administrator’s impact on the division process
Your attorney should check with your spouse’s retirement plan administrator before drafting a QDRO. He or she will have to approve the language contained in the QDRO and may actually 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 that 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 is one that 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 of charge consultations six days a week with a licensed family law attorney. We represent people in our community just like you with a great deal of pride and respect for their goals.