Most of my divorce clients are in their 50’s or older, often described in the media as “gray divorces.” These couples’ retirement accounts are their largest assets. Unfortunately divorcing individuals often don’t understand the rules of dividing retirement assets in divorce nor how complex the division process can be. What they don’t know, will hurt them.
Not just a paragraph in the decree
When it comes to a divorce, it is crucial to use a QDRO (Qualified Domestic Relations Order) to divide the qualified plan accounts. Qualfied plan accounts include defined contribution plans such as 401(k), 403(b) plans and defined benefit plans (pension plans). Plans that are not divided via QDRO include but are not limited to IRAs, deferred compensation plans, executive bonus plans, group carve-out plans, stock options, and restricted stock.
Without a QDRO, the amounts that are split between divorcing spouses, as well as subsequent withdrawals, are subject to federal taxes and early-withdrawal penalties. There are many details to consider in every QDRO, but the first step is agreeing on the split — either a percentage division or a dollar amount division of the account.
Percentage versus dollar amounts
I’ve seen instances of both methods, but I am wary when a couple wishes to divide an account in terms of dollars instead of percentages. For example, if the total account value is $800,000, and they wish to split the account 50-50, the decree might state that one spouse will be awarded $400,000. The couple assumes that $400,000 will still be half the account value at the date of divorce, so the decree is silent on the amount of retirement funds the other spouse will be awarded. The risk here is that if the investments lose value, one spouse will be awarded $400,000 while the other spouse will be awarded less than $400,000.
I am aware of a case where spouse A had to pay additional funds to spouse B, because they had agreed to a dollar amount division with a specific dollar amount to spouse B. Between the time the decree was filed with the court and the day the account was actually divided, the retirement account had lost so much value that the funds remaining in the retirement account were insufficient to fund the amount that was awarded to spouse B. Spouse A was not only left without retirement funds, but also had an obligation to pay spouse B a sum to replace the shortfall of funds awarded to spouse B.
What he didn’t know hurt him
Husband had saved money by doing his own divorce without legal advice. He had a pension for his retirement. He and Wife #1 agreed to split his pension with her getting a $30,000 lump sum. They had gone their separate ways, assuming the retirement account split would be taken care of by virtue of the divorce decree.
After several years, Wife #1 tried to get her lump sum payment from his pension. The pension administrator told her that lump sum distribution to her was not an option and furthermore, since there was no QDRO on file, she had no right to the pension. She began nagging her ex-husband to remedy the situation. When he didn’t, she escalated with a threat to prove that he was still married to her. This made Wife #2 very unhappy. I was brought into the mix to straighten out the mess. In retrospect, he regretted his attempt to cut costs during the divorce. He ended up spending more to fix the problem than he would have if he had sought professional advice for the divorce. He told me the resulting emotional price was also too high.
Avoid buyer’s remorse
Most times one member of the divorcing couple is in a hurry to get the deal done. The other half might be still reeling from the realization that they are in a divorce. This is called differing divorce readiness. During the course of the divorce, the reeling spouse tries to slow down the process while the other spouse tries to speed up the process. These push-me-pull-you dynamics can result in increased frustration for both spouses. As the divorce progresses, spouses can come to a point where they both want to slam through the financial settlement just to stop the emotional pain.
It is important to slow down enough that the couple understands all the details of the proposed financial settlement. For pension plans, details include early retirement subsidies, post-retirement cost-of-living adjustments, form of alternate payee’s payout (lump sum or monthly check) and pre-retirement survivorship protection for the alternate payee. For defined benefit plans, details include plan loans, dealing with account value gains and losses, alternate payee’s commencement date and delayed plan contributions.
Rushing through the process at this point can result in buyer’s remorse after the divorce. In my collaborative law divorce cases, clients are encouraged to take the time to carefully and fully understand these details. Doing so can have a profoundly favorable effect on their future financial stability. The collaborative law divorce process, while usually faster than traditional litigation, builds in the time and professional advice to assist the clients and their attorneys in designing a property division that fully addresses both spouses’ needs.
About Tracy Stewart
Tracy Stewart, CPA is your financial expert for advice, guidance and support through many seasons of life. Whether it's navigating the choppy waters of divorce, reacting to a transition from a relatively healthy active adult to an adult with a serious illness, or running a forensic analysis of your finances to build a detailed picture of separate assets, I can help you come up with a plan for the needs of today — and the goals of tomorrow.