Regardless of whether you’re divorcing in your 30s or your 60s, it’s important to pay attention to retirement assets such as a pension. In this podcast, Chicago divorce lawyer Arin Fife outlines what you need to know about the different retirement plans that may come up during a divorce – such as IRAs, 401(k)s, and 403(b)s – and how they’re divided. She also discusses the role of QDROs in a divorce, whether or not Social Security benefits can be divided, and much more.
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Hosted by: Diana Shepherd, Editorial Director, Divorce Magazine
Guest speaker: Arin Fife, Family Lawyer
Arin Fife is an attorney at Boyle Feinberg, P.C. who practices in all areas of family law. She is a highly skilled mediator and litigator who counsels clients on a wide range of divorce-related issues, including maintenance, child support, and financial compensation. Arin takes great pride in empowering her clients to resolve their disputes and helps ensure their smooth transition through the complexities of divorce. For more information about how Arin and her firm can help with division of retirement assets, please visit www.boylefeinbergfamilylaw.com.
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Read the Transcript of this Podcast Below.
What are the different types of retirement plans that might come up in a divorce?
There are really two main types of retirement plans: the defined benefit plan and the defined contribution plan. When most people think of retirement plans, they’re usually thinking of a defined contribution plan. This type of plan is an employee sponsored plan with an individual account for each participant. The benefit is fully based on the contributions made by either or both the employee and the employer. These accounts are IRAs, 401(k)s, 403(b) accounts, and sometimes profit sharing.
The defined benefit plan often is referred to as a pension plan. These types of plans calculate benefits using a fixed formula to calculate a monthly lifetime payment that typically factors in final pay and the number of years of service with the employer.
What’s the difference between a traditional IRA and Roth IRA?
These are both defined contribution plans, as I just discussed, but the main difference is the way that the contributions are taxed. A traditional IRA, similar to a 401(k), is not taxed when contributions are made, but they are taxed at the time they are withdrawn.
With a Roth IRA you will pay regular income taxes on the money when it’s contributed; however, when that money is withdrawn, you’ve already paid the taxes and there is not an additional income tax. There are some other differences and qualifications which really should be discussed with a qualified financial advisor when looking at what’s the most appropriate plan for you.
For someone getting divorced in their 30s or 40s, retirement can seem like a long time away. Why is it important to pay attention to the pension during divorce?
It really is an easy thing to overlook and undervalue these assets when there’s something like a pension which seems so far off. But it is important to never forget that in assets, such as a pension, without great consideration even though it may be some time before that benefit is actually seen. Pension benefits can be very valuable and can grow considerably over time. You really don’t want to overlook those. It’s never too early to be planning for your future, even in your 30s and 40s.
How is a retirement account valued at the time of divorce?
There are a couple of ways to value these accounts and that really depends on what type of plan it is. A defined contribution plan is much easier to value and therefore easier to divide within the divorce. The defined contribution plan has a certain value as of a certain date, which can be divided as either a percentage or a dollar amount to the other spouse.
A defined benefit plan is valued as a future stream of payment based on a benefit formula. Most defined benefit plans are pension plans, which will not pay a lump sum amount and will only pay a spouse on a monthly basis for a lifetime starting around retirement age. The actual value is usually unknown until that benefit begins on that later date.
How is a retirement account divided?
When dividing assets the client must really consider whether to divide the retirement account either by dollar amount or percentage or to negotiate a trade-off of the types of assets such as the marital home. However, the client must really be cautious when contemplating a trade-off of this type. Considerations should be made for things like taxes. For example, a defined contribution retirement account will be taxed as income when the funds are later withdrawn. However, the home’s net value is really in after-tax dollars. Those tax implications have to be considered when dividing the retirement accounts.
What is a QDRO and when is it used?
If you’re dividing a retirement account that is qualified, such as a 401(k) or a pension, your attorney will need to prepare a QDRO, which is a qualified domestic relations order. This is an order that will be entered with the courts that is then sent to the planned administer of the retirement account to effectuate the division. Non-qualified plans such as IRAs can usually be divided with a simple letter of direction and don’t require a QDRO.
Can a retirement account be both marital and non-marital property?
It absolutely can. When an account was in existence before the marriage, a portion of it may be non-marital. That portion will not be subject to division in the divorce. With a prime contribution plan, it’s also impossible to determine the account balance as of the time of the marriage.
A good piece of advice maybe upon a later remarriage is to retain that last monthly statement prior to the marriage and all year-end statements thereafter, which will make it much more simple in the event of a future divorce to determine which portion is marital and which is non-marital and what is actually subject to division.
What if it’s not possible to determine the balance at the time of marriage?
If this is the case, a formula can be used to determine the non-marital portion of that account. You can simply multiply the average yearly contribution times the number of years worked prior to the marriage. The problem with doing this is that it really is an imperfect method. The premarital portion can easily be overestimated, especially in long-term marriages, as we all know as people age their incomes usually increase along with their contributions to a 401(k) or an IRA. This average can kind of be skewed and often over-value that premarital portion.
Is a spouse who never worked entitled to a share of their working spouse’s pension or retirement accounts?
A spouse who has never worked is absolutely entitled to a portion of their spouse’s marital retirement accounts. All money earned during the marriage is marital money which is subject to division in a divorce.
Can Social Security benefits be divided on divorce?
The actual Social Security benefits cannot be divided. This is because the Social Security benefits are regulated by the federal government and there is really no way to divide them and effectuate that through those regulations. However, this does not mean that a former spouse is not entitled to a portion of their spouse’s Social Security benefit, including survivor benefits. As long as they have been married for at least 10 years, their work credits do not exceed half of their spouse’s, and they do not remarry, they may qualify for these benefits.
This makes it an important consideration if you are in the process of divorce and you are approaching your 10-year marriage date. It may be beneficial to delay the divorce a little bit. Once you pass that 10-year mark you’re entitled to these benefits and there’s really no negative effect to your spouse in doing so.
If someone needs money today to pay divorce-related expenses, is there any way of gaining access to retirement funds they’ve acquired during property division without incurring the 10% penalty for early withdrawal?
There is. As we discussed earlier, with a QDRO this can allow a divorcing spouse under the age of 59-and-a-half a one-time withdrawal of money from certain accounts without incurring that standard 10% early withdrawal penalty. The catch to this is that this withdrawal must be performed through a QDRO. But it can be very useful when needing to pay unavoidable expenses such as attorney’s fees incurred in the divorce.
Everyone must, however, remember that this money will eventually be needed to live on, so it really should be carefully thought about and only when absolutely necessary be withdrawn. Also remember that the funds withdrawn, while they’re not subject to the 10% early withdrawal penalty, they will usually count as taxable income for that year.
Once a divorce is complete, is there anything else that needs to be done with regards to retirement accounts?
It is very important to follow through with the division of the retirement accounts. The QDRO, which hopefully was entered the same day of the divorce with the judgment, needs to be submitted to the plan administrator for approval. Additionally recent cases have made it very clear that when it comes to federal retirement plans such as pensions and even things like life insurance benefits, a change of beneficiary notice is mandatory. Clients should really make sure that it is a priority to immediately remove a former spouse as a beneficiary from an account. This can be done by making sure that that beneficiary designation form is up-to-date.
You mentioned that it’s important to have the QDRO entered promptly upon divorce. Why is this important? Could it be a problem if it isn’t?
It could be a problem if it isn’t. Unfortunately, it is not uncommon that we see cases where years have gone by and the QDROs have not been entered. It’s one of those things that can fall through the cracks once you’re divorced. You think everything has been done, but the division of these retirement accounts is not actually effectuated and people don’t realize this for years and years to come. This can create some major problems with the estate, and if someone does pass away prior to the entry of the QDRO, the retirement accounts don’t always listen or adhere to what a divorce decree says. It’s not a necessity that the QDRO be entered at the same time as the judgment, but to make sure that it’s not forgotten or overlooked, we as practice like to try and do that.
This doesn’t mean that if in someone’s particular case that that hasn’t been done that it can’t be done. The QDROs can be entered after the fact, and hopefully this is prior to anyone’s passing away or circumstances which will complicate the issue. But they can be entered after the fact and should be entered as soon as it comes to anyone’s attention that it has not done so.