One of the most challenging aspects of a divorce is determining how to divide your assets and liabilities.
If your marriage is ending, there are some important things to consider before shared assets are divided up.
Splitting a joint checking account is relatively straightforward. However, determining how to divide retirement funds, such as a 401(k) in a divorce, can get complicated. When dividing up your assets, 401(k)s can be one of the trickier items to deal with. Here are a few points you should keep in mind when splitting a 401(k) in a divorce.
Understanding How Your 401(k) Works
401(k)s are one of the most common retirement savings vehicles and can be a valuable asset during a divorce. This is why you should first know a few things about splitting up and protecting a 401(k) in a divorce.
The first step is to understand how your 401(k) works. This includes understanding how much money is in the account, how it is invested, what fees you pay, and how much if any, income taxes will be due when the proceeds are withdrawn. You should also be aware of any loans or withdrawals made from the account.
What is a QDRO, and how does it affect a 401(k) in a divorce?
Dividing a 401(k) is more complicated than dividing up other assets. This is referred to as a Qualified Domestic Relations Order (QDRO), which determines the amount of money each partner will receive. Essentially, it is a court order issued by a judge.
There are a few different ways to distribute or divide a 401k in a divorce.
Rollover the Money
The first option is to rollover the 401(k) assets into your qualified retirement plan via a direct transfer request. This option is ideal if you do not need the money, as it allows you to avoid paying taxes and penalties on the transferred amount. This also allows you to hire an advisor to manage the funds.
Defer Taking the Money
Another option is to leave the money with the current 401(k) plan administrator. Even though your assets will be divided per the divorce decree, this option may not be the best. This requires less paperwork but generally leaves you with less flexibility and fewer investment options.
Cash It Out
Lastly, you can cash out your portion of the 401(k). This is typically the worst option as it will result in additional taxes and penalties. If you desperately need money, you may be forced into taking this option.
If funds are needed, it is best to have them distributed from the 401K before transferring them to your account. You will likely pay taxes on this amount, however, you will avoid the 10% penalty if you are under 59 1/2.
Tips on how to divide a 401(k) in a divorce
Hire a Financial Advisor
A financial advisor can help you understand your options and make the best decisions for your future. They can also help you negotiate a fair divorce settlement with your spouse.
If you have questions about dividing your 401(k) or other financial matters, click here to request additional support.
Get Help from an Attorney
Always contact an attorney or qualified advisor if you are having trouble dividing your 401(k) in a divorce or determining which assets are marital property. An attorney can help you understand the law and ensure you are protected during the process.
Understanding a QDRO
If you have a qualified domestic relations order (QDRO), you may be able to divide your 401(k) without having to pay taxes on the account. A QDRO can successfully be used to divide a 401(k), but it must be done correctly to avoid penalties.
5 Key Takeaways About Splitting up a 401(k) in a Divorce
1. Make sure you have an accurate account balance. This may seem like a no-brainer, but ensuring you have an accurate account balance before divvying up assets is essential. This way, you can get an equitable distribution and ensure there are no nasty surprises later on down the line. Make sure you know the account balance on the date being used to determine the value of all assets. Typically, this is the date of separation.
2. Keep in mind the tax implications of withdrawals. When withdrawing money from a 401(k), you will usually be subject to taxes and penalties. Make sure you factor this in when deciding how to divide the assets.
3. Get a lawyer and qualified financial involved. Dealing with 401(k)s can be complicated, so hiring a divorce attorney is always a good idea. They can confirm the marital assets that are subject to a division in a force, ensure everything is done correctly, and help you navigate any tricky legal waters.
4. Be prepared for a long process. Splitting up a 401(k) usually takes time and effort, so be prepared for it to take some time. It’s essential to be patient and work through the process step by step to ensure everything is done correctly. You do not want to find out later that you owe taxes on retirement accounts or other assets.
5. Have realistic expectations. It’s unlikely that you’ll come to an agreement where both sides are 100% happy, but as long as you’re both reasonably satisfied with the outcome, that’s usually good enough.
How to Protect Your 401(k) in a Divorce
A prenuptial or postnuptial agreement is a great way to protect your 401(k) or any asset, especially if you live in a community property state.
If you do not have an agreement and your assets are commingled, you will need to determine how to divide them. It is essential to evaluate all assets on an after-tax basis. This will require you to choose a reasonable tax rate for qualified assets which are typically pre-tax dollars (meaning taxes will need to be paid when the money is withdrawn).
Conclusion – How to Divide a 401(k) in a Divorce
We’ve discussed why dividing up a 401(k) in a divorce can be difficult and more challenging than dividing up other shared accounts.
Because this process can become complicated, it is best to consult with a qualified financial advisor before getting married. If you are already married and getting divorced, consult with a qualified attorney and financial advisor before you agree to a settlement.
If you are considering a divorce or in the process, download our free guide, here: