Retirement benefits

Divide, Buyout 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 we see are defined benefit plans (think: pensions), profit sharing plans, 401k’s, IRA’s and other deferred compensations benefits.

Your first inquiry is determining whether all or any of the retirement asset is community property. The asset is all or partially community property to the extent employee or employer contributions were made during the marriage and before separation. The amount of the contributions during marriage plus any gains or losses since date of separation is the community portion. Community property is ordinarily divided 50/50.

Second, determine the value of the community property portion of the retirement account(s). You can estimate yourselves (and agree on a value) or you can use an actuary (financial professionals or lawyers who specialize in retirement division and/or equalization).

Note: The value for some retirement account(s) is simply an estimate. For example, to value most pensions, actuaries look to such factors as the average male/female life expectancy, projected rates of return on investments and estimated future earnings.

Dividing retirement plans is tricky and must be done correctly to avoid tax consequences such as an early distribution penalty for removing assets before the age required by the plan. If you and your spouse agree to divide the community portion of each retirement account separately, you can skip step two (above) and proceed directly to a specialist who can prepare the agreement and order that divides/segregates each of your interests in the benefit(s). You may also ask your plan administrator for a sample Qualified Domestic Relations Order (QDRO) if you want to prepare the orders on your own (proceed with caution!)

Third, once you know the value of the community interest in the retirement plans, you and your spouse need to determine how you will divide and/or equalize your respective interests. 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.

Another option is to assign each retirement plan to the spouse who accrued the benefit. To the extent one spouse receives a higher amount, there are a few options to equalize the interests:

The party who receives a higher value of retirement assets can buy out the other spouse using a non-retirement asset. So, for example, if husband receives $100,000 more retirement assets, he must pay wife 50% of that amount (as her share of the community property). He can give her $50,000 in cash or a different asset equivalent to that amount (or somewhat less to compensate for tax consequences upon ultimate withdrawal or receipt of the retirement monies). The parties can prepare an order (see above) on one (or more) plans to equalize the benefits that each party receives. The parties can agree to cash out one (or more of the accounts) to pay the spouse who has less in retirement (but be aware of serious tax consequences that will likely occur!).

There is no one size fits all approach to dividing retirement accounts. Definitely seek the advice of a trusted lawyer if you have questions on this topic.

See also: Understanding QDROs: Dividing Retirement Plans in Divorce

Pin It on Pinterest