One of the things that divorcing couples often forget to consider is what happens to the 401K in a Bellevue divorce. You’ve worked most of your life, and as a result, you’ve contributed a good amount to the company’s 401K retirement fund. You’ve been setting aside money for those years when you plan to enjoy your hobbies and spend time with friends and family.
You’ve been paying your dues, but now your spouse wants to divorce. That leads to the question of whether your spouse is entitled to half of the 401K in a Bellevue divorce. Continue reading to learn what happens to your 401K when you decide your marriage is no longer working.
Parties in a divorce can always agree on how to split up the marital property, including the retirement accounts for one or both of them. Reaching a divorce settlement agreement has several advantages, not the least of which is that it can save you time and money. Reaching a settlement agreement also means that you have more control over what happens to your property and other assets.
Regardless of whether you agree on splitting your property and retirement assets or the judge decides for you, it’s essential to understand that each state has rules for dividing property after a divorce. Those rules may or may not apply to your retirement accounts. Understanding these rules will better prepare both parties for what happens during settlement negotiations or even a trial.
Most states have rules of equitable division when it comes to dividing marital properties after a divorce. The judge will be tasked with determining what is fair for property division under the state’s rules. In some states, judges begin with the assumption that all property and other assets should be divided equally, but if appropriate, they can order an unequal division. Some states, like California, require that all community property be split 50-50 in a divorce.
Usually, spouses are allowed to keep their separate property after a divorce. Sometimes, though, if the state has the equitable division rule, a judge may include all of the assets in the divorce settlement, whether those assets were marital or separate. Basic restrictions for property division apply to retirement accounts too, but some rules are specific to 401Ks, IRAs, and pensions.
In a community property state, any assets that either spouse purchased or earned during the marriage are considered joint property regardless of who acquired the asset. That means that any financial resources gained during the marriage, including retirement funds, are divided equally. Washington is a community property state, and so are Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, and Wisconsin.
Other states follow what is known as equitable distribution rules, and the courts will divide property in what they consider an equitable manner. In other words, the marital property will be divided fairly but not necessarily equally. That means that 401K or IRA earnings may not be split equally.
Since Washington is a community property state, let’s look at how an equal division of assets affects a 401K account in a Bellevue divorce.
If you have a traditional 401K account, the judge would order the funds accrued while married to get split in what’s known as a Qualified Domestic Relations Order. One spouse could have a 401K while the other doesn’t, so half of the 401K would be distributed to the spouse who had not contributed to a 401K. The spouse who receives the assets can choose to put them into a retirement account in their own name or take the distribution outright. Outright distributions are subject to income taxes.
Traditional IRAs work in a similar way in which half of the funds in the IRA that was accrued during the marriage would be transferred into a different IRA to benefit the other spouse. Big-name brokers have programs for setting up an IRA in this situation that is quick and easy to deal with. Any withdrawal from a traditional IRA, other than the initial transfer between spouses, results in income tax and could result in early withdrawal penalties depending on how old the original IRA holder is when the withdrawal occurs.
An even split of retirement accounts could be easiest, but it might not be best. Therefore, all tax implications should be considered before dividing your assets.
When both parties have a 401K or IRA account, it might be possible to hold on to your respective retirement accounts. If one of the accounts is valued higher than the other, the Qualified Domestic Relations Order or a transfer to the spouse with the lower valued 401K. If there are other financial assets, those might be used to equalize the property division allowing both spouses to keep their personal 401K accounts. As always, the tax implications should be considered.
When it’s time to divide your 401K with your soon-to-be-ex-spouse, it’s wise to begin with a conversation with your plan administrator. Every plan has a set of benefits provisions and administrative rules. Some plans divide assets by percentages, while others divide assets by shares. Some will allow the distribution of the assets when the divorce is final, while others will require that the recipient reach retirement age before receiving funds distribution.
After learning what the plan administrator requires for the distribution of 401K assets, one of the following four options may become available for dealing with the distribution of your 401K assets:
Often, attorneys consider this the least complicated option, but dividing the 401K using this method requires careful research with resulting financial calculations. Before choosing this route, you should consider at least two economic factors to help ensure that you and your spouse stay on equal financial footing: the long-term tax consequences and the current and long-term values of the assets being divided.
If you want to split the 401K assets directly rather than argue about who should get what, you will need a Qualified Domestic Relations Order (QDRO, pronounced “Quadro”). A QDRO is a court order that provides for an alternate payee (your ex, in this instance) to receive all or part of your plan account benefits. The QDRO is a judgment or order that is made based on the state domestic relations laws in your state and that relates to child support, alimony, or marital property divisions.
Typically, the least complicated procedure for establishing a QDRO is to state that your 401K will be split into two accounts. Doing this allows you to continue to manage and invest in your current 401K, while your ex can make decisions for their own account, but they won’t contribute to it. When you become eligible for distributions, your ex-spouse will also become eligible.
You must meet specific requirements to allow for this kind of distribution. The tax consequences also need to be considered when looking at this option. If you choose the option of liquidating your account, you likely want to ensure that your spouse will be responsible for the tax liability associated with liquidating the account.
This option has limited availability. It’s only available if you’ve left the company or reached 59 ½. The benefit to rolling over into an IRA is that you can remove your ex’s share of your 401K plan from the 401K without tax liability or other penalties. It also allows your ex to choose from more investment options, allowing them to have more control over account management.
These tips can give you the knowledge you need to avoid issues when you split your 401K.
It’s always best to talk to a CPA or financial planner when you are preparing financial documents for your divorce proceeding. This can help both you and your spouse prevent unnecessary mistakes.
Before making any financial promises to your soon-to-be-ex-spouse, it’s wise to consult an attorney to learn what your rights and responsibilities are in your state. Contact the Aberdeen Law Firm at (425)333-2737 to discuss your situation with a qualified divorce attorney.