Dividing Investments, IRAs, and Pension Plans During Divorce
When a couple is divorcing, all of the assets need to be divided. This includes less tangible assets like investments, IRAs, and pension plans. In many ways, these assets are divided like other types of property. First they need to be characterized as marital or separate property. Then the marital property needs to be divided between the spouses. Often, whether the state is a community property state or an equitable distribution state, the assets that were acquired during the marriage will be split relatively evenly between the couple. However, investments, IRAs, and pension plans have unique characteristics that can make dividing them more difficult.
As a general rule of thumb, each spouse is often entitled to half of the assets acquired during the marriage. However, sometimes only part of a particular asset was earned during the marriage. For example, if someone earns a pension after 20 years of working, and has worked ten years and was married during those years, then the ex-spouse may be entitled to one quarter of those benefits. (The worker has earned half the benefits during the marriage and their ex-spouse is likely entitled to half of that.) This type of asset division can get very complicated, so it is best to consult with a skilled divorce lawyer to help you make sure that you receive all of the assets that you are entitled to.
It’s good to first decide if you want to be able to get money out of an investment when you need it, or are more willing to let an investment mature. This will have an impact on how you divide your investments up.
Part of the value of many investments is the income that has been earned on them. Generally, if the appreciation of a given investment has occurred during the marriage, the parties will split the profit. However, there are exceptions. A common exception is a situation where the asset was acquired before the couple got married, but the earnings happened during the marriage. Whether that increase in value is the property of both parties or just one of them will depend on the nature and character of the income. Some investments may be considered separate property if they were bought before the marriage and were passively held in a separate account during the marriage.
One of the important considerations in dividing IRAs and similar assets is taking the tax implications of the division into account. There are provisions in the tax code that allow couples to transfer assets to each other subsequent to divorce without having to pay taxes on any appreciation. However, it is important that you consult with your divorce attorney to make sure that you are aware of any potential tax consequences both during and after the division. This is especially important in situations like those involving a 401(k) where part of the investment involves tax-deferred contributions. You will also want to be aware of the tax consequences of any investments that are liquidated incident to divorce.
Be Careful of Penalties
Most retirement accounts impose penalties on early withdrawal, even if you are withdrawing the money to buy your spouse out of their share of your account. Instead, you may be able to roll funds over to another retirement account.
Investment and retirement benefits are often earned well before they are used. That means that while the benefits were earned during the marriage, it may be years or decades before they will be paid out. That leaves spouses with choices around how to divide those assets. One way that those benefits are divided is for the spouse to wait until the benefits are paid to collect their share. However, this can keep spouses tethered to each other after the divorce which can be an issue for some couples. Another way for benefits to be divided is for one spouse’s share to be discounted to its present value and then paid out by the other spouse or offset with other assets.
It is important to work with a knowledgeable divorce attorney if there are IRAs, pensions, or other investment income that need to be divided. One big reason is that different investment tools require different processes. For example, if it is an IRA being divided it’s considered a “transfer incident to divorce.” However, if it is a 401(k) that is being split, you will need a Qualified Domestic Relations Order. An experienced divorce lawyer can help you navigate this often confusing area of law.