Getting divorced? Troubled marriage? Start thinking about what will happen to the money in your 401(k), profit-sharing and other employer-sponsored retirement plans. The folks in Washington, D.C., are.
Most people think their company savings plan is a personal piggy bank, but it’s not. During a marriage, money that accumulates in a 401(k)-type plan is marital property.
That means you have to share it with your spouse exactly as you would with a conventional pension plan.
Trouble is, unlike pensions, employees can take money out of their mutual-fund-laden 401(k) accounts without their spouses’ consent. In particularly rancorous split-ups, spouses have been known to loot their own 401(k)s before the divorce–if only for spite.
Some thought that loophole in the 1984 Marriage Equity Act would be remedied by the Taxpayers Relief Act of 1997. A provision in the Senate version would have extended pension protections to 401(k) plans by requiring married employees to get a spouse’s permission before taking money out of such retirement accounts.
But employer groups fought the measure, arguing that it would have cost too much–a charge experts in 401(k) administration say is exaggerated. At any rate, the issue was left out of the final version of the bill.
“It would stop someone from draining the money out of the account in a bad marriage or before a divorce,” says David Certner, legislative expert with the American Association of Retired Persons. “This is an important protection.”
Indeed, one North Carolina homemaker married for 20 years discovered, to her distress, that after separating from her husband, a life-insurance salesman, he began withdrawing large amounts from his 401(k) to pay his lawyer’s fees and court-ordered spousal support. There was nothing she could do about it except resolve to fight for some equivalent asset later in court.
“It’s always possible that one spouse will take the money out in advance of a divorce since one can empty out the plan without a spouse’s knowledge,” says Mark Sullivan, an attorney in Raleigh, N.C.
Even dual-career couples have to think about what will happen to their 401(k)-type assets in the event of a breakup.
After her 10-year marriage to a retired investment banker ended, Helga Justman, a social worker in San Francisco, was surprised when her ex-husband demanded half of the $25,000 she saved in her 403(b) plan during their marriage. But she got a bigger shock when she discovered that because her ex’s retirement savings had accumulated before the marriage, she wasn’t entitled to any of his retirement money.
Since the government failed to address the problem, here are a few guidelines to remember:
First off, the amount divisible in a profit-sharing, 401(k) or 403(b) plan is anything that accumulated from the date of the marriage to the date of separation or divorce, depending on your state.
What if there’s been a loan? (About a third of corporate 401(k) plans have loans outstanding.) Generally, a person who borrows from his account will be liable for the money in a divorce. For instance, suppose a person with a $100,000 401(k) account borrows the maximum allowed, which is 50 percent of the account balance to as much as $50,000. In that case, the spouse would be entitled to the remaining $50,000.
However, that’s a working guideline, and judges have a lot of control over the final decision. For instance, if the loan were used to remodel the kitchen, the court could decide that the couple benefited equally from the loan. Hence, the spouse would receive only half–$25,000–of the remaining account balance. (The account holder would still have to repay the loan.)
Hardship withdrawals can be trickier, because withdrawals from retirement plans are fully taxable–and also face a 10 percent penalty in most cases. That means, if a couple files jointly, they share the tax burden equally–even if the employee spent the money in anticipation of the divorce.
Again, there’s lot of leeway in the courts. If the money were withdrawn to pay medical bills for a sick child, the withdrawal might be seen as the couple’s joint liability. But if a judge determined that the money were taken out simply to prevent the other spouse from obtaining his or her share, the account holder could be ordered to forfeit assets of equal worth, assuming the person has any assets.
To obtain a share of your spouse’s 401(k) in such a situation, your lawyer must submit a “qualified domestic relations order,” or QDRO (pronounced “kwadro”) to your spouse’s benefit plan. The court order will prevent your spouse from withdrawing the assets and must be submitted before a distribution is made. (Even if a couple amicably decided to split the assets, a distribution made without a QDRO would become fully taxable.)
Ann Fallon, a lawyer in Richmond, Calif., says to watch out for plans that have only one or two dates a year when earnings are allocated to the account. For instance, she says, a client’s ex-spouse had an allocation date of June 30; by waiting two weeks before demanding her share, her client was able to receive her share of the yearly earnings, which came to about $1,800.
It can take a while to get the money. Delays often occur because the QDRO is incorrectly written, so make sure your lawyer gets a copy of the retirement-plan document, which has the information needed to file a viable QDRO.
Once the employer gets a properly written order, it is supposed to comply quickly. But many drag their feet because they are unfamiliar with the law, or figure, incorrectly, that they have 18 months. Distribution can also be delayed for other reasons.
So what happens when the money is finally released? It can be rolled directly into the spouse’s individual retirement account, where it remains tax-deferred until withdrawn. However, if the money is distributed, the spouse who receives it will owe income taxes on the full amount, though not a 10 percent penalty in a divorce.
Working couples, each with a retirement plan, may decide simply that each will keep their own plan. That civilized solution also requires that you get it in writing; if you don’t, the courts will still assume that the assets are marital.
Whatever you decide, make sure you change the beneficiary, or the money could go to your ex-spouse when you die.
