What You Need To Know To Protect Your Finances
You’ve worked hard over the years and have set aside a big nest egg for your retirement through your company’s 401(k) plan. Or perhaps your spouse has been the breadwinner while you’ve taken care of the kids, but you know that the family 401(k) is sizeable. What you might not have anticipated is the consequences divorce could have on employer-sponsored retirement plans. Here are some commonly asked questions and answers:
Q: Are 40l(k)s marital or separate property in the case of divorce?
A: Typically, the amount in a 401(k) accumulated during the course of a marriage is considered marital property.
Q: I know my spouse has a large 401(k) and I’m afraid that if (s) he thinks I might file for divorce, he’ll borrow from the plan or make withdrawals. How can I protect myself?
A: This is a potential problem for dependent spouses. Some plan sponsors/employers require spousal consent for an employee to take out a loan or make a withdrawal from his/her 401(k). But this depends on the plan document of the employer. Most employers do not require spousal consent.Once a divorce is pending, you can phone up the plan’s record keeper and ask them to flag the account so your spouse cannot take out a loan or withdraw from the account. Some record keepers will do so.
Q. By what mechanism are 401(k)s divided in divorce?
A: By a Qualified Domestic Relations Order (QDRO). A QDRO is a decree, order, or property settlement under state law relating to child support, alimony or marital property rights that assign part or all the participant’s benefits to an alternate payee. While generally, the alternate payee is the spouse, it could be a child or other dependent.
Q: Can I avoid an early withdrawal penalty if I cash out part of my share of a 401(k) that I receive during divorce proceedings?
A: Yes. When the 401(k) is divided, you have a one-time opportunity to take money out of your 401(k) if you are the alternate payee without paying the normal 10 percent income tax penalty for withdrawing if you’re under 59 ½ years old. However, it is likely that you will have to pay income tax on this distribution.
Q: If I’m the alternate payee, what can I do with my share of the 401(k)?
A: If you want to keep your share of the 401(k) in a tax deferred account, you can roll it into an IRA. The benefit to this option is that you can continue to contribute to the account and you have a wide range of investment options. Alternatively, you could stipulate in the QDRO agreement that you’d like to leave your share in the existing 401(k) plan. The plan’s administrator will create a separate account for you. However, your ability to add and withdraw from this account might be tied to your ex-spouse’s retirement plan. You may find that by rolling your share into an IRA, you have more autonomy over your money.
