Avoid financial pitfalls in divorce.
Each year, more than 800,000 people get divorced in America. If you’re going through a split, you may find it difficult to think of complicated financial matters while facing such an emotional period. You might even be tempted to put your brain on autopilot, and have someone else make all of the decisions. But in order to ensure happier days ahead, there are a few things you need to keep in mind to protect your retirement funds.
Familiarize yourself with a QDRO.
The Qualified Domestic Relations Order is a document used by the courts to divide qualified retirement plans such as pensions and 401(k)s. “The QDRO will become part of your vocabulary,” says Connie H. Buffington, a family law attorney at Boyd Collar Nolen & Tuggle in Atlanta. “The approval is a complex process. Start early because you need to know what will be permitted in the split of the pension plan before you can calculate other aspects of dividing assets.”
Make sure the QDRO is approved by the retirement plan.
“One mistake we see is QDROs that are unclear or delayed,” says Terri R. Munro, a wealth advisor at BT Wealth Management in Atlanta. The plan administrator should be contacted early in the divorce process to ensure the division of the assets squares with the plan’s rules. “Ensure the QDRO outlines a specific date of division, and if the division includes gains or losses since that date. Income benefits such as pensions may have to be recalculated based on the receiving spouse’s life expectancy,” she says. “This can take months, and delays can create problems if one spouse is counting on a cash payout to live on.”
Find out what options your retirement plan allows.
“While all plans are governed by federal law, there are substantial differences in how they allow assets to be divided in a divorce. I’ve found that some also can be slow to cooperate,” Buffington says. “You, the ex- and the retirement plan administrator — it’s an awkward threesome.”
Be aware of the value of the plan after taxes.
For instance, if the divorcee is in the 25 percent tax bracket, that $100,000 in 401(k) funds is really only worth $75,000, says Gary Silverman, founder of Personal Money Planning in Wichita Falls, Texas. “I’ve seen an instance where one spouse trades an IRA or 401(k) for a smaller taxable account or personal items. It might look like they are giving their partner a good deal, but once taxes are considered they come out ahead.”
Roth plans have more value.
A Roth IRA or Roth 401(k) is more valuable than a traditional IRA or 401(k). This is because the taxes were paid at the time of contribution into a Roth IRA or Roth 401(k), says Michael Fuhr, a certified financial planner at SageVest Wealth Management in McLean, Virginia. As a result, qualified distributions are tax free. “Whichever spouse will be in a higher tax bracket than the other after the divorce could consider offering a concession on something else, in return for retaining the Roth IRA or Roth 401(k) assets,” he says.
Consider a complete split of a defined benefit plan.
This means both spouses take half of the assets and establish their own accounts where they are in control. “If you don’t take this path, then the spouse who ‘owns’ the retirement plan benefit makes the decision on when benefits will start for both parties,” Buffington says. You don’t want your plan tethered to an ex- who wants to work a decade longer than you do because you’ll have to wait that decade for your own benefits. “Conversely, if he takes early retirement with a lesser benefit, she has to go along with that decision. And if he dies first, her benefit payments stop, although she may receive a survivorship benefit if the benefits are not split.”
A shared interest approach might work.
The shared interest approach allows the employee participant to remain in control of a pension while the former spouse piggybacks on the benefits, Buffington says. It has one major advantage for the employee: “If the former spouse dies, all the value of the plan reverts back to the plan participant,” she says.
Minimize tax liabilities when withdrawing funds.
“If you must take the cash, pull it from the 401(k) because the law allows a one-time distribution in a divorce without paying the normal 10 percent penalty for early withdrawal. Take it from an IRA and you’ll have to pay the penalty,” Buffington says.
Protect retirement and pension plans.
This is particularly important during a divorce. “Once someone starts drawing on a pension plan, there’s no turning back,” says Buffington, because the terms are set and there’s no option to create a separate interest for the other spouse. “Maintain the status quo on the pension plan until you’ve agreed on all the terms of the divorce.”
Remember deferred compensation plans and stock options.
Deferred compensation and stock options should be considered in the settlement, and the parties should work out a formula for paying the associated future tax liabilities, Buffington says.
Change beneficiaries.
A divorce usually nullifies any outstanding wills, but many forget to change the beneficiaries of retirement plans, Munro says. If your former spouse is designated as a beneficiary in the plan, he or she will receive the benefit regardless of what a new will or state law outlines. “This can be a rude surprise years later to a new spouse who assumed he or she would receive those benefits,” she says.
Use a financial planner.
“We live and breathe the numbers — tax strategies, interest rates, fees, actuarial calculations,” Munro says. “We can work with your attorney to educate you on the trade-offs in various strategies for dividing assets, especially the tax considerations.” The financial planner can also partner with your attorney to consult on technical aspects of different account types, help you to be hyperconscious of liquidity issues, start communications with the retirement plan sponsor early, and remember to remove your former spouse as a beneficiary.
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12 Steps to Protect Your Money in Divorce originally appeared on usnews.com
