What Happens to My Retirement Savings During Divorce?

Saving for retirement is a smart thing to do. It’s an investment in your future comfort and financial security that you likely crafted with the idea that you and your spouse would reap the benefits together. If you’re now facing divorce, retirement savings set aside during marriage are assets that need to be split as part of the equitable distribution process, but doing so is complicated by both state laws and tax policy.

If you live in a community property state that requires marital assets be split evenly in a divorce, then the first thing you need to do is identify what assets are community property, which are not, and what each spouse’s individual assets are. Any retirement savings set aside prior to marriage will not be included in an equitable distribution. If retirement accounts are included in marital assets, both spouses should be interested in dividing them in the way that avoids losing their tax benefits. Avoiding liquidation of tax-deferred accounts makes sense, and can be done with careful analysis and cooperation.

If each spouse has their own retirement account then the value of each can be compared. Ideally the two accounts hold roughly the same value, allowing each to walk away without any liquidation or division required. If liquidation is required in order to make things even, then more than the account’s value needs to be considered: tax ramifications also need to be calculated. For example, funds are withdrawn from a traditional 401(k) for distribution they will be taxed, while liquidation of a Roth 401(k) will not trigger taxes because its original contributions were made with after-tax dollars.  The goal for both spouses should be to minimize a tax impact that lowers the overall value of the combined assets, so cooperation on these complex issues is important.

One way to avoid a negative tax impact is to weigh the value of retirement savings against the value of other marital assets. Equity in the marital home, a vehicle or other investments or cash accounts can serve as a counterbalance to an individual spouse’s retirement accounts. If that is not possible and a portion of a 401(k) needs to be liquidated, you will either need to make a withdrawal from your 401(k) or to obtain a court order known as a qualified domestic relations order, or QDRO, which gives your spouse rights to some of the funds. A QDRO usually creates two new accounts, allowing each party to manage their own. If there are tax ramifications from either of these transactions then responsibility for the taxes will need to be part of your agreement.

Dividing the value of retirement accounts is one of the more challenging aspects of divorce, but an experienced divorce attorney can help you navigate the process. For assistance with this and other issues, contact our firm today to set up a time to discuss your situation.