Investments, IRAs, and Pension Plans in Divorce
When a couple is divorcing, all assets are divided, including less tangible assets like investments, IRAs, and pension plans. In many ways, these assets are divided like other types of property. First, they are characterized as marital or separate property. Then, the marital property is 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, this type of asset division can get very complicated, so it is best to consult with a skilled divorce lawyer to ensure that you receive all the assets to which you are entitled.
Ownership
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, a spouse who earns a pension after 20 years and worked for 10 of those years while married may owe their ex-spouse one-quarter of their benefits. (The worker has earned half the benefits during the marriage and their ex-spouse is likely entitled to half of that.) As factors and timing become more complicated, an actuary or other financial expert, in addition to a divorce attorney, may be helpful in calculating marital property.
Investment Income
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. An actuary or other financial expert may be helpful in determining how to divide investment income, especially when investment contributions have not been consistent or steady, such as a varying 401(k) contribution.
Taxes and Penalties
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.
Most retirement plans impose some sort of early withdrawal penalty. Recipients must also pay tax on withdrawals of any tax-deferred contributions. To avoid these costs, spouses may instead elect to roll the funds over into their respective accounts. For some plans, like 401(k)s, a Qualified Domestic Relations Order (QDRO) may be worded to ensure that funds are transferred “trustee-to-trustee” to avoid penalties and taxes. A QDRO may also specify that benefits paid out of a pension plan are divided so that each party is responsible for their share of the tax liability. Other plans, like IRAs, do not require QDROs for division but may benefit from a QDRO or similar document outlining exactly how funds will be transferred to avoid tax liability and penalties.
Timing and Division
Investment and retirement benefits are often earned well before they are used, and it may be years or decades before they will be paid out. Therefore, spouses must decide whether to divide and collect these assets during divorce or much farther into the future. Spouses may opt to wait until benefits are paid to collect their share. However, this can keep ex-spouses tethered to each other too long for comfort. Spouses may instead discount these assets to their present value and exchange the funds or offset their value with other assets.
Some retirement plans, like 401(k)s and IRAs, are relatively easy to value. These assets’ values are simply the value stated on the most recent account statement. Once the asset’s value is determined and divided, the appropriate funds can be rolled over into each spouse’s separate account.
Pension plans are more complicated to value and divide. Since a pension plan’s value usually accounts for an employee’s years of service and yearly salary, its value will be uncertain until the employee retires. Divorcing spouses may want to hire an actuary or other financial expert to predict the future value of the pension plan, although they should keep in mind that the number will only be an estimate. Sometimes this uncertainty is best resolved by an agreement that the other spouse will receive a percentage of the benefit as it is paid out, but spouses who want to divide the value of the pension early should take into consideration the risk that the plan is worth much more or less than its valuation.
Process
It is important to work with a knowledgeable divorce attorney if there are IRAs, pensions, or other investment income that need to be divided because processes differ and can become complicated. For example, the division of an IRA is considered a “transfer incident to divorce,” and a letter to the plan administrator along with a copy of the divorce order will suffice. However, certain assets like 401(k)s and pensions require a QDRO. Plan administrators may also have their own requirements and processes. An experienced divorce lawyer can help you navigate this often confusing area of law.
