In many divorces a major source of assets considered in the property division includes employer sponsored retirement plans and accounts like IRAs funded by prior retirement plans. These retirement plans can house significant financial resources. The parties to a Dallas or Fort Worth divorce may want to conserve them for retirement, may need to spend now, or may want to invest differently.
Unlike checking and savings accounts where money can easily move in and out, employer retirement plans like 401ks and defined benefit pensions are governed by complex laws that limit the ability to tap into these resources and divide them. Today’s post will discuss some of the concerns with employer-sponsored retirement plans in a divorce in Texas.
1. How secure is the retirement benefit?
Most employee retirement plans fall under regulation by legal mechanisms to ensure retirement assets do not disappear into the night. Most private employer plans fall under ERISA (employee retirement income security act of 1974). ERISA sets out a number of requirements for how an employer must administer the plan.
These include requiring the plan’s financial assets held in a trust, the plan must subject itself to IRS and DOL reporting requirements and for defined benefit plans the plan must subscribe to a federal insurance program similar to FDIC protection on bank accounts.
Government plans may or may not be ERISA plans and can be separately protected by the funding obligations of the state or federal government although many state and local government pension plans have funding problems.
Some plans are not well protected by law and the employee’s benefit is only as secure as the employer’s financial security. It is important to understand the risk of losing benefits when dividing retirement plans in a divorce.
2. How are retirement benefits accessed after the divorce?
Most retirement plans come with restrictions on the timing of distributions that can be a concern if one or both spouses has a need or interest in withdrawing funds from the retirement plan for living expenses or other purposes. Most defined contribution plans, like 401k plans, allow the party receiving a divided share of a retirement plan (the alternate payee) to receive benefits fairly easily after a divorce.
However, similar plans like ESOPs can have more restrictions even on alternate payees. That can present problems when there is an urgent need for money. Defined benefit plans, commonly referred to as pension plans, have greater restrictions on distribution timing and payment method.
As the alternate payee you may have to wait until you or the participant reach retirement age to receive funds. Knowing the plan’s distribution rules is important for parties considering making an immediate distribution after the divorce.
3. What are the tax considerations?
Most retirement plan distributions will incur taxes and this can have a significant impact on your tax bill. Depending on your age you may also be subject to the 10% early withdrawal penalty. Certain distributions to the participant and most distributions to the alternate payee avoid that penalty; but it is important to consider who and why distributions occur to try to reduce the tax burden.
4. What will it mean to keep financial assets in the retirement plan?
Many plans present opportunities for the alternate payee to remain in the plan and keep the assets in the same tax-deferred status and investments but whether this is the right course for an alternate payee depends on a number of factors. The plan may have significant fees for account administration and investment access. These fees eat away at the benefits and may impair investment growth.
The plan may not offer the best investment options available to the participant. Other plans or accounts may be available to the alternate payee that can accept a rollover of plan benefits. Some people use retirement assets to finance businesses or real property and that may be an option. Whether staying in the plan is an option, is the only option, or is in the best interests of an alternate payee depends upon the person’s individual financial circumstances and the plan rules.
5. How do you I divide the plan benefits in a Texas divorce?
Many employer-sponsored retirement plans have specific rules and procedures for dividing benefits in a divorce. For 401k plans and other ERISA-governed plans, employers require a qualified domestic relations order (QDRO). A QDRO is a court order instructing the plan administrator to divide benefits according to the division in the divorce.
QDROs are complex and must comply with specific plan rules and regulations. Some non-ERISA plans can be divided by completing forms from the plan or providing a copy of the divorce decree.