Yours, mine or ours? Divorce can take a nauseating bite out of your retirement savings, whether you live in a community property or equitable distribution state. You can make your 401(k) less appetizing to the court if you can show that your soon-to-be former wife doesn’t deserve quite as big of a bite as she wants. Accomplishing that, though, can be a tall order.
A Fair Split
Indiana is an “equitable distribution” state. The state’s law is quite specific: “The court shall presume that an equal division of the marital property between the parties is just and reasonable.” Equitable, though, does not necessarily mean equal. A husband can present evidence that demonstrates why an equal division would not be just. Such evidence might include the length of the marriage. For example, in a 25-year marriage, an even split is usually equitable. However, in a marriage of six months, the division of a husband's 401(k) is likely to be weighted in his favor. Other evidence might include whether the 401(k) was opened before or after the marriage and the economic circumstances of each party and their earning potential.
Retirement Savings = Marital Asset
Money you earn and save during your marriage is a marital asset, and 401(k) contributions and earnings are no exception. Retirement accounts are among the most divided assets in a divorce. As such, Congress has relaxed tax laws and penalties regarding 401(k) transactions subject to divorce.
Dividing the Spoils
So you work things out and agree on a property division or the court orders one after a trial. If your 401(k) plan is divided during divorce, the most common way to transfer funds is a "qualified domestic relations order" or QDRO. A QDRO is a court order permitting the transfer and distribution of 401(k) funds to the wife. A QDRO gives the former spouse the right to receive all or some of the benefits payable to the plan participant, the husband. The plan participant is not taxed or penalized for the distribution. Afterward, the wife must decide what to do with her share of the money.
Rollover or Cash Out?
The parties submit the QDRO to the 401(k) plan administrator, who is required to follow the court’s instructions regarding the assignment or distribution of funds. The wife has four options. She may leave the money in the husband’s 401(k). If the plan is producing good returns, why not? A second option is a direct rollover into a separate Individual Retirement Account. If the wife needs cash, she can take it prior to the rollover. In this case, some of the money will be subject to IRS withholding, but the balance is protected. The final option is to cash out. However, the wife will be required to pay IRS taxes and penalties if she’s younger than 59½.