Retirement benefits

Divide, Equalize and Offset or Cash Out Retirement Accounts?

There are several types of retirement benefits that you or your spouse may have. The IRS provides descriptions of the different plans here. The most common plans are defined benefit plans (think: pensions), defined contribution plans such as profit sharing plans and 401k’s, and IRAs. Most mid to large employers have 2 types of plans for their employees – a defined benefit plan and a defined contribution plan.

Your first inquiry is determining whether all or any of the retirement asset is marital or community property. The asset is all or partially marital or community property to the extent employee or employer contributions were made during the marriage.

Then you basically have 2 choices. You can either divide the retirement benefit or you can figure out the value of it (equalize) and offset it against some other marital asset.

Choice 1:  Divide the Retirement

When you get a divorce the ONLY way to get money paid from one spouse’s retirement account to the other  spouse is with a QDRO. Simply stating that that the spouse is awarded a community or marital property interest in a retirement asset will NOT divide the benefit!

A QDRO (pronounced ‘Quad-ro’ for those in the know) is a court order which is used to divide a retirement plan. The actual order may be a Qualified Domestic Relations Order for a private plan or Domestic Relations Order for a public plan.

Hello Divorce works with QDROCounsel a legal technology company for pension division founded and backed by a team of nationally recognized QDRO and Valuation experts. You can use their service to get support, coaching and guidance from these experts including QDRO attorneys. For more information on QDROs, you can also consult our other resources:

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Choice 2:  Equalize and Offset Retirement Account

Parties may also agree to figure out the value of the retirement accounts and then offsetting that account against some other asset. But note that because the values may not be identify, you still may need a QDRO for the offset amount!

What are the most common equalization and offsets?  The most common equalization and offset occurs when the parties have many defined contribution plans (e.g. 401ks) and/or IRAs between themselves and they want to offset them against each other and divide only 1 defined contribution plan with a QDRO.

Can there be an offset against defined benefit plans or other assets?  Parties may agree to equalize and offset a defined benefit cash balance plan or a traditional defined benefit plan against other assets.   This is certainly possible but generally not recommended unless the marriage is very short.

Why?  Defined benefit plans function differently than a defined contribution plan (e.g. 401k) or IRA.  Unlike a defined contribution or IRA when there is a known account balance as of a certain date, for a defined benefit plan, there is no value until the participant actually starts the benefit.  Because there is no value to a defined benefit plan until retirement, the value must be actuarially calculated based on the present date with values that are estimates.  Therefore, when a defined benefit plan is equalized and offset against another asset, there is no way of knowing if the offset award is overstated or understated.  There is no way of knowing whether the offset is fair.

What determinations must be made to prepare for an equalization and offset?

First, you first determine the value of the retirement benefit and any other property being equalized and offset.  If there any separate property interest in any of the plans, you will need to figure out what is separate property and what is marital or community property.

Warning:  Each of the benefits to be offset are most likely invested differently from the date the equalization and offset is calculated to the date of distribution.  If investment choices in each of the benefits differ in any substantive way, then one party could end up with less than the other at date of distribution. If the investment choices are very similar, then it should not make a significant difference because both parties will be allocated the same investment earnings and/or losses at date of distribution from each of the respective plans in the offset.  An equalization and offset will NOT result in a perfect division.  The most accurate division of benefits is to divide each plan separately.  Regardless, especially with defined contribution plans and IRAs, it may make sense to “horse trade assets” based on estimates depending on the parties’ situation!

How does an equalization/offset calculation work?

The calculation generally works as best shown by the following example:

(1) Determine the Date of Division:  e.g. 12/31/2016.  (In almost all cases the Date of Division is the applicable marital division date based on your state’s law, court order or the parties’ agreement.)

(2) Determine that the total marital/community interest for each of the benefits as of the Date of Division as follows:

Party 1 Benefits:

ABC 401k Plan                     $100,000

DEF 401k Plan                      $200,000

Party 2 Benefits:

XYZ 401k Plan                                                 $50,000

Total marital/community interest:              $350,000

Each party’s marital/community interest:  $175,000

(3) Party 2 is awarded 100% of Party2’s XYZ 401k Plan benefits in the amount of $50,000

(4) Party 2 is awarded Party2’s remaining total marital/community interest of $125,000 ($175,00 – $50,000) from Party1’s DEF 401k Plan as of Date of Division, plus investment earnings and/or losses thereon.

(5) Party 1 is awarded 100% of Party1’s ABC 410k Plan of $100,000 and the remaining balance of the DEF 401k Plan after payment to Party 2 of Party 2’s share via a QDRO.

Are there any tax advantages in dividing defined contribution plans separately versus doing an equalization/offset?

With a QDRO for a defined contribution plan, the alternate payee (nonparticipant spouse) has the option to move funds to an IRA or other qualified plan or take the funds as cash. However, if the alternate payee wishes to receive those funds as CASH and NOT roll them into an IRA or other qualified plan, then the alternate payee’s funds will be subjected to taxes but NO tax penalty for early withdrawal if younger than 59.5. See Internal Revenue Code Section 72(t)(2)(C).

So, if the parties each want defined contribution funds as cash directly from the other’s plan and are willing to pay taxes on those funds, then it is better to do a QDRO on each qualified defined contribution plan and not do an equalization and offset.

If I am the participant, should I just cash out my retirement plan, if possible? Cashing out is usually not advisable since, except under rare circumstances. The spouse who withdraws will have to pay ordinary income taxes plus an early distribution penalty. Sometimes, one spouse can take a loan from their plan(s) to purchase the other’s interest in it.

There is no one-size-fits-all approach to dividing retirement accounts. Definitely seek the advice of a trusted QDRO expert if you have questions on this topic.  If you are not sure what to do, it is always best just to get a QDRO done for each retirement benefit for a fair division.

Want a free consultation about filing a QDRO? Our partners at QDROCounsel are ready to help. Click to learn more.

See also: Understanding QDROs: Dividing Retirement Plans in Divorce

Please note that this resource is meant for informational purposes only and does not constitute legal advice. Reading this blog does not create an lawyer-client relationship with Levine Family Law Group, Hello Divorce, QDROCounsel, LLC or QDRO Benefits Law Group. This blog is written from the perspective of existing law and all attempts are made to be accurate and current on all legal developments. However, please do not make decisions that will affect your future based on things you’ve read on our website. Instead, consult with a Certified Family Law Specialist, like those of LFLG – or any other you prefer. The same goes for QDRO-specific questions: you may consult with QDROCounsel, LLC or QDRO Benefits Law Group or any other QDRO specialist you prefer – but be sure to seek out sound legal advice that pertains specifically to the facts of your case.

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