, next to perhaps the home. Regardless of the value in these retirement plans, 401k plans and pension plans, many couples mishandle these accounts in divorces. The result can be a substantial financial loss for one spouse, sometimes even for both. Today’s post will detail some of the most common ways people in Texas divorces mishandle their retirement plans. The best way to protect your retirement assets is with the help of a divorce lawyer who understands retirement plans.
1. Ignoring retirement assets in a divorce in Fort Worth, Texas
I hear often people about to divorce decided not to bother with dividing the 401k or other retirement assets. The rationale offered is usually that the process seems too complicated or the account balances are “about the same”. I will agree that sometimes it makes sense not to divide the retirement accounts. Especially when the balances in each 401k is fairly similar. However, it should never be the case that these assets are untouchable or off the table. A closer look at the assets should occur. Here are some reasons why:
- Both accounts may not be all community property subject to division. Any portion of either account accrued before marriage is separate property of the spouse who accrued those assets. They are not subject to division in a divorce. That may mean while both accounts have $100,000, one spouse may have only community property; but the other spouse has $50,000 of community property and $50,000 of separate property. Equal division of community property means the spouse with the 401k only during marriage gets half the community property portion ($100k plus $50k) at $75,000. The spouse with the 401k before marriage gets the other half of community property plus the separate property for $125,000. If that spouse keeps only what is in his or her account then that spouse just gave up $25,000.
- If the retirement accounts are off the table you may not receive a division of property that benefits you most. To dividing retirement plans, many spouses resort to dividing other property. The time period after a divorce is one of the most financially dangerous times in any person’s life. Especially if you are taking primary conservatorship of the children. DVDs and stuff in boxes you haven’t used in ten years won’t pay bills. I rarely encourage people to cash out retirement assets after a divorce; but it may be your only source of money. Furthermore, that tax-advantaged money is worth way more than the fondue set you used once.
- Using the tax-advantaged nature of the retirement assets can net you a financial win. In certain situations where the spouses carry substantial debt or cannot divide the value in the family home, splitting the retirement assets can net a long term financial gain. Of course, every marriage is different and that advantage may not exist in all situations.
2. Not using a QDRO to divide retirement assets in the Tarrant County, Texas Divorce
This is probably THE WORST THING YOU CAN DO. A substantial number of people who try to DIY their own divorce think when they divide retirement assets, particularly the 401k, that whoever is giving up part of the account should take a withdrawal and give it to the other spouse. No. I mean, it’s a great deal for the recipient; but an extremely stupid move on the part of the person giving up part of the account. When you take a withdrawal from a 401k or other retirement plan, that withdrawn portion is taxable income. And if you are under 59.5 years of age, you also get to pay a 10% penalty to the IRS. That is bad. Why pay taxes on behalf of your ex-spouse?
Domestic relations orders
The right way to divide retirement assets is through a domestic relations order. A domestic relations order is a court order, issued after the divorce, that instructs the retirement plan to divide the account based on the division ordered in the divorce decree. In the case of an ERISA governed plan, which includes 401ks and most defined benefit pensions, the plan administrator qualifies the order (determines it follows the plan rules) and it becomes a qualified domestic relations order, or QDRO (pronounced like “quadro”).
The QDRO then allows the plan administrator to divide the account (often referred to as segregation) with no tax consequences to the account owner. The plan administrator will then set up an account for the recipient, called the alternate payee, or make a direct distribution to the alternate payee. The alternate payee is responsible for the taxes on that portion. The alternate payee may also roll over the assets to his or her own retirement account and defer the taxes. (That has an effect on whether the alternate payee will pay that 10% penalty.)
3. Using a website or the plan administrator’s example forms to draft a DRO
Using a low-cost website or even free forms from the plan administrator or a plan service vendor can save money up front but here’s what you don’t know about those options: the forms are designed to make segregation easy, not to do what is in your best interest. The plan administrator wants qualification of the DRO to be easy. That’s why plan administrators make template forms available. Websites also want qualification to be easy because then you’ll be happy with their services.
That sounds ok, but a generic DRO may not properly preserve your rights under the plan to additional sums or the most favorable calculation of your share of the account. You could lose a noticeable amount of money that way. That is especially true with defined benefit pension plans because the benefit formula is so complex and there may be survivor benefits or future benefit increases that you could capture (or retain) based upon the language of the DRO.
With pension plans it is common to see those website-constructed DROs (like what legalzoom offers) fail to be qualified because they do not adequately describe how to segregate the benefits under the plan’s benefit formula or QDRO processes. That means you may spend the money to have a new DRO drafted multiple times.
4. Waiting to submit the DRO to the plan administrator to qualify the order
Often people do not understand the QDRO process. As a result, the decree may award a division of assets but the assets never get divided. It is the responsibility of the alternate payee to see that he or she gets the DRO submitted and qualified. The account holder should not impede the process but he or she is not responsible for making sure the assets are divided or the DRO is submitted. At some point in the future the account holder may decide to have his or her retirement assets distributed out of the plan.
Eventually the plan administrator will not keep the account locked up and let the owner have his or her money. Once that happens it’s up to you to follow the much more expensive and difficult process of tracking down the money and getting it out of another account, if it still exists somewhere.
Once you get divorce you need to have the DRO prepared, signed and submitted to the plan administrator.
5. Letting your ex-spouse change the terms of the division after the decree is signed
Judge signed the divorce decree, everything done? Not necessarily. You still have that QDRO to deal with and that means a second judicial order needs to be signed by the court. The judge isn’t going to compare the DRO against the decree. He or she will assume you did that before you agreed to the DRO yourself. Often people try to tweak the terms of the decree or add language that has the effect of changing the division when drafting the DRO. Template forms copied verbatim may read differently than the decree. You could end up with something less than what you agreed to if you let your ex-spouse (or soon to be ex-spouse) draft the DRO and you sign it blindly. Your lawyer should be carefully reviewing the DRO to assure it conforms to the decree.
Sometimes ex-spouses will decide they don’t like that the account balance dropped due to market changes before the DRO processes and want you to pay out of your own pocket for what your account gave up to the market. If the DRO calls for a division of the account based on the ongoing investment of the account then that’s what the alternate payee agreed to and that’s what he or she gets. You don’t owe him or her anything else.
6. Leaving mention of the retirement accounts out of the divorce decree
Maybe you decided you and your spouse do not want to divide retirement accounts, so you don’t mention them as separate property in your decree. The problem is that property that is undivided by the decree may be subject to later division, especially if your ex-spouse claims the accounts were undisclosed (whether they actually were or not) or the value of the accounts was not properly disclosed. The last thing you really want to do after your divorce is finalized is go back through the whole process and let your retirement assets get divided although you two once agreed they would not be divided.
In cases where retirement accounts are not identified as separate property in the decree, one spouse will start to believe he or she did not receive a fair shake and start trolling the internet looking for ways to squeeze more out of you. Once he or she realized the retirement assets are absent, he or she may use the threat of going back to court to get you to volunteer concessions. The problem is that when you concede to these threats you put yourself in a cycle where that ex-spouse will promise to leave you alone if you do X but then later will come back with the same threat and make you give up something else.
Do it right the first time. Properly identify all financial assets in the decree.
7. Not protecting the retirement accounts before finishing the divorce
If a divorce lacks temporary restraining orders then nothing will stop the account owner from clearing the account. While spouses should not hide assets during a divorce, trying to track the money down may prove difficult. A plan administrator should place a hold on distributions once it learns a DRO is imminent. Unfortunately not all plan administrators quickly put those in place. Without notice they have no reason to know that they should place a stop on the account.
When filing for divorce, a TRO is necessary prevent liquidation of financial assets. A copy should go promptly to the plan administrator with a letter explaining that a DRO should follow.
Get help from a Texas divorce lawyer
Texas divorces are financial minefields. Seemingly small decisions can have broad, dangerous impacts on your financial well-being and in turn your life. That is why it is important to work with a Fort Worth divorce lawyer who understands the risks involved and how to mitigate them. By the time you discover problems in your Texas divorce it may be too late to change the divorce decree or undo the financial harm caused. Trying to take future action even with the help of divorce lawyers in Fort Worth, Texas will at a minimum be substantially more expensive than hiring a divorce attorney at the beginning of your divorce.