Based in Linwood New Jersey, family lawyer Cynthia Ann Brassington is certified by the Supreme Court of New Jersey as a matrimonial law attorney. She helps people resolve their divorce-related issues – from prenuptial agreements to alimony and child support to property division. In this podcast, Cynthia answers questions regarding divorce and retirement accounts – including the division of qualified pension plans, employee benefit plans, and Qualified Domestic Relations Orders.
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Guest speaker: Cynthia Ann Brassington, Matrimonial Law Attorney
A panelist on the Matrimonial Early Settlement Panels in both Atlantic and Cape May counties, Cynthia also taught family law as an adjunct professor for Atlantic Cape Community College. She is certified by the New Jersey Supreme Court as a Matrimonial Law Attorney.
Hosted by: Diana Shepherd, Editorial Director, Divorce Magazine
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Read the Transcript of this Podcast Below.
1. If only one spouse worked outside the home during the marriage, are contributions to that spouse’s retirement account considered marital property or separate property?
All property that is legally or beneficially acquired during a marriage or a civil union is subject to equitable distribution. Now this includes retirement accounts and pensions that take on different forms. There could be a 401K account, an IRA, a profit-sharing plan, a 403B which is common among the medical profession, just to name a few.
2. You just mentioned an IRA which, I think, is an individual retirement account. What’s the difference between an IRA and a qualified pension plan?
Well, that’s a great question again. A qualified pension plan is different from an IRA, specifically by the tax treatment. Now, I’m going to refer to not so much as a pension plan for this question but for a saving, such as a 401K, just to be clear, as I’m answering your question.
When you put money into a 401K from your paycheck it is tax deferred, in other words you don’t pay any taxes on that money. You get it completely tax free. Your employer may match it, 2%. 3%. 4%, whatever the plan provides, and then you get to save that money and let it build in accordance with the market, and it’s completely tax deferred until at some time point in the future when you are permitted to withdraw that money.
However, when you put money into an IRA, you’ve already paid taxes on that money so while the interest you are accruing on that IRA, you’re putting that money in and you’ve already paid the taxes on it. So you see how it’s already the tax treatment. Well, that’s one difference but there’s others.
But I’d like to address the difference in the way we divide a qualified account from a non-qualified account, in divorce. For example, when dividing a 401K we use an instrument called a qualified domestic relations order. Some people call it a “cue-dro” and some people call it a “qua-dro,” but, essentially, this is an instrument that we use to divide a tax deferred account so that when your spouse has been saving money in a tax deferred account, that account can only be divided in a certain fashion by a QDRO.
The alternate payee, and that’s the spouse that is not named on the plan, receives his or her share of the plan through this QDRO. Now, when the alternate payee receives his or her share of the 401K, 403B, profit-sharing plan, whatever that particular plan is, they will receive their benefit tax free. However, if they roll it over into an IRA by way of a QDRO, that money will go into the IRA without tax consequences. However, if they withdraw the money, they’re going to have tax consequences on that money. Now that’s if they’re taken from a qualified plan.
If we are dividing an IRA, it’s different. Some IRAs do require a QDRO, some do not. However, if you are under 59 and a half, you’re going to get your money – if you cash it out – you’re going to have your tax consequences plus you’re going to have a 10% penalty and that is the difference. That’s why it’s so important to know what kind of plan we’re dividing, because if I have a client who was waiting for that money and they’re saying, I’m going to cash this out, here’s what I’m going to do, I say to that client, “well, wait a minute, what are your tax consequences? Where do you fall on tax consequences?”
If I have a client that is a 33% tax bracket, federal, and then I’m looking at their state tax bracket and then they’re going to pay another 10% penalty, they could be looking to pay a significant portion of their IRA that they’re going to lose to taxes and penalties, and it doesn’t make sense. So for that client I would encourage that client to reinvest that money and avoid that downward spiral of the money.
Also, something else to look out for when you’re in a divorce is, if your spouse has a 401K, 403B, one of these qualified plans, and they change jobs, the job is going to dictate that they may have to remove that money from the 401K, the 403B, and then roll it into an IRA. If they do that, what’s going to happen if you were depending on that money, now you’re looking at an additional 10% penalty. If I see that coming I would write to the plan and see what I can do to see if we can keep that money in the plan till the divorce is finalized.
So it’s important that clients are aware of the different plans, the tax consequences of these plans, as they do their retirement planning as well as their divorce planning, when entering into a marital settlement agreement.
3. What’s the difference between a defined benefit and a defined contribution pension plan?
A defined contribution plan and a defined benefit plan are different and they can be identified by the wording of them. For example, a defined benefit plan is this: You don’t know what you’re going to be putting in every week. It might be 6% of your salary, 6.5% of your salary, 7% of your salary, depending on the plan, but you know what you’re going to get back. You’re going to receive back the average of your last three years of salary prior to retirement.
So it could be, for example, some plans are 50% of the average of the three years, some plans are 40, some plans are 60. So depending on what you have in your plan, that will define your benefit so we know exactly what your benefit’s going to be.
However, with a defined contribution plan you know what you’re going to put in. You’re going to put in 4% of your salary. If it’s a 401K or a 403B, for example, for profit-sharing, you know what your employer is going to put in at the end of the year but you really don’t know what you’re going to get back because it depends on market forces. That money could go up, it could increase in value or it could go down, it can decrease in value, depending, again, on the market forces.
4. 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 but, again, this is why we have to always look to the type of plan that you have. There is something called the pendente lite period. Now pendente lite is Latin and it basically means pending the litigation. The period of litigation begins with the filing of the complaint for divorce and it ends with the entry of the final judgment of divorce. During this pendente lite period we can, with a court order called a QDRO, qualified domestic relations order, take money out of that 401K or that 403B.
The way to do that – there are actually two ways to do that – is to file a motion with the court and ask the court and say, “I know I’m going to receive a certain percentage of this qualified plan.” I usually do it with a letter from an actuary that says the plan has a value of, say, $100.000, the marital portion is $40,000, so this way the judge knows exactly what percentage my client is going to receive in equitable distribution.
If my client needs money now, I will file a motion. I might need $20,000. Now my client knows that that $20,000 is going to be taxable to her but because we’re doing it with as a qualified domestic relations order on a qualified plan, she will not have a penalty. So we take that money and then she’s going to owe her taxes on it. We work, again, with the tax expert to figure out exactly what those taxes are going to be or as close as we can realistically get to them and that is the money that is available to fund litigation, maybe pay off something that has to be paid off and things of that fashion.
However, you cannot do that with an IRA. An IRA will not be divided between the two parties until after the entry of the final judgment of divorce and, with an IRA, if you’re less than 59 and a half years old, you’re going to have that 10% penalty.
5. Can the non-employee ex-spouse receive benefits before the employee ex-spouse retires?
Well, again, it depends on the plan. When I have a defined benefit plan, I write to the plan. Sometimes I can find the plan documents online which is common nowadays. If I can’t find it online, I will write to the plan because it’s good to have the plan document which is going to tell you exactly when that employee can take his or her share of the other spouse’s pension.
Some plans say that you can’t touch it until the other spouse is of retirement age. Whether they retire or not is irrelevant. Once they get to retirement age, you can take it. However, there are other plans that you have to wait till that spouse retires, whether or not that spouse has reached retirement age, before you can get your share of that plan. That’s why you have to know exactly what the plan is and when you’re going to receive your funds, when you do your marital settlement agreement, so you can effectively do divorce planning with your client.
Something else I want to explain is the curvature fraction. It sounds a little complicated and it’s not as complicated as it sounds but we do use experts to define exactly what a spouse will receive. When we divide a defined benefit plan, we have to look for how long the party – we call the plan participant – how long the plan participant was in the plan during the marriage and how long the plan participant was in the plan during the entire period of employment.
So, for example, if the plan participant was in the plan for ten years during the marriage, that is 120 months. You would divide that 120 months by the number of months that the plan participant was in the plan with the employer. That’s going to give you your curvature fraction which now defines the marital portion and then the spouse, the alternate payee, normally will receive 50% of that.
It may be subject to adjustment for agreement or by some equitable distribution fashion such as if there was a pension loan during the marriage but we can safely say that we’re feeling that approximately 50% of those funds will be received by the alternate payee and then that alternate payee will receive those funds when she or he is able to do so under the dictates of the plan. I always say that pension plans are like snowflakes; every single one of them is different.
6. Does New Jersey consider non-vested retirement benefits to be marital property?
Oh, absolutely. In marital property, again, it goes back to that original statement I made when we first started this interview: All property, legally and beneficially acquired during the marriage or civil union, shall be subject to equitable distribution. Non-vested retirement benefits are still an asset and they are unvested until they become vested. So a lot of plans might say you vest after ten years. Let’s assume for a second that you’re in that plan for eight years during the marriage. But if that spouse remains in the plan, at some point they are going to vest and at some point it’s going to become a viable asset and when that happens we have the qualified domestic relations order which will then define the plan benefits and what that spouse will receive upon retirement.
Sometimes people think that because it’s not vested that it doesn’t have value, but it does have value. And, again, it goes back to the plans. When you have a pension plan that is fully funded by the employer, if it doesn’t vest it’s worth zero until it vests. You still want to have that qualified domestic relations order in place because the person may continue to work and vest that account.
On the other hand, if it’s an employee-funded plan, that means that the employee is going to put in their percentage share and the employer puts in their percentage share and that builds and then that eventually goes into the account and from those funds you are earning your pension. If you leave that plan before you vest, you’re going to receive back the monies that you invested into that plan during the marriage so those funds, again, are subject to equitable distribution.
When we do the QDRO we include distribution of those funds so that in the event the plan does not vest and it’s an employee-funded plan, then the alternate payee still receives his or her share of that account. But, again, Diana, it always comes down to the plan and that’s why it’s so important that you obtain a copy of the plan, that you understand the plan because you’re negotiating something and it should not be done in a vacuum.
7. I’d like to end by asking one question about social security benefits. Can someone qualify for social security retirement benefits based on the earnings of his or her ex-spouse?
I’m glad you asked about social security benefits because this is an important aspect of every person’s retirement planning, especially someone who is divorced and did not work. The person who is divorced, so long as they were married ten years to the person that paid into social security, and that person qualifies for social security, then the spouse will receive a portion of that person’s social security benefits. However, how much they receive and when they receive it depends on the year they were born and their age.