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Are you considering divorce? Beware of retirement account breaks

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Divorce can seem a little different for older couples. They usually don’t have to worry about child support or the custody of young children. But separating the old-age assets they hold jointly and those that each spouse owns separately is another matter.

Along with the marital home, retirement accounts are often an older couple’s most important asset in divorce proceedings. When both spouses have retirement accounts, the combined balances should be factored in with all other assets, says Laura Medigovich, Certified Financial Planner and Senior Financial Planner at Janney Montgomery Scott LLC in Purchase, NY.

The rules for splitting retirement assets differ depending on the type of account (IRA, 401 (k), or pension) and can be complicated. And transferring retirement funds to a former spouse can have unintended tax consequences if done poorly, so the stakes are high to get it right. On the one hand, you need a Qualified Family Relations Order (QDRO) to transfer a 401 (k) account or divorce pension rights, but not many divorcing couples can find out. The order, which is issued by a court or public body, recognizes the right of a divorced spouse to receive all or part of the defined contribution plan or the account holder’s pension.

There are two ways to divide plan assets using a QDRO. The first grants a separate interest on the account balance. The second allows a divorced spouse to participate in the payment of benefits. Once both parties agree to the terms, the account owner delivers the document to the plan administrator. Since writing a QDRO can be expensive, Medigovich recommends that you ask your divorce lawyer to ask the plan administrator to provide a QDRO language template.

“Compared to a pension split, a 401 (k) is a much easier asset to split,” says Medigovich. This is because you know the value of the account. If one of the spouses has a 401 (k) worth $ 200,000, the divorcing couple could agree in the QDRO to divide the account equally. In this case, $ 100,000 of the 401 (k) balance can be transferred directly to the other spouse’s IRA without incurring federal income tax or penalty. This changes, however, if the spouse who receives the money pockets the $ 100,000 instead of having it transferred to an IRA. Then he or she will owe tax on the money, but there is no 10% penalty for early distributions, even if the spouse taking the money is not yet 59 and a half. . If the $ 100,000 is transferred to the spouse’s IRA and that person makes an early withdrawal, then the money is subject to both income tax and the 10% penalty.

Pensions are even more complicated to distribute. Not only does each employer have different rules for how or if a pension can be split, but you will also need to hire an actuary to calculate the present value of future benefits. It is easier to split a pension when the retired spouse has already started receiving benefits. Then you can use a QDRO to divide the payments into dollars or a percentage.

QDROs do not apply to IRAs. To divide an IRA between spouses, the terms must be specified in the divorce or legal separation agreement, which the account owner gives to the sponsor of the IRA. In order for the money to be divided without taxes or penalties, the agreement must specify that a percentage or dollar amount of the account owner’s IRA balance must go to a spouse’s IRA as part of a transfer. direct from trustee to trustee. If the beneficiary spouse withdraws money during the transfer, he will owe taxes on this withdrawal and, if he is under 59 and a half, a penalty of 10%. Likewise, an account owner who takes an IRA distribution to give to a spouse in the event of a divorce will be taxed on the payment (and will owe a 10% penalty if he is under 59 and a half).

If possible, use a Roth IRA for a spouse who wants the money. A Roth is more tax-efficient because withdrawals are generally tax-free.

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