Dividing the Loot — Retirement Accounts
Recently, after reading a blog post here about the Van Loan formula, someone wrote to ask how a retirement account would be divided up in a divorce and whether there was a form or calculator that could be used to do this. Like most answers given by lawyers, the answer is “It depends” and “Be very careful.”
The first question to ask is what kind of retirement account is it. Generally there are two types of retirement accounts – defined contribution accounts and defined benefit plans. Defined contribution accounts are accounts like Individual Retirement Accounts (IRAs) and 401(K) plans. Also included are TSP accounts held by government and military employees and deferred compensation plans. Defined benefit plans are what I call “old-fashioned” pensions – based on your pay and years of service, when you retire you receive a monthly pension payment that continues on until your death.
Retirement plans are governed by the federal law called ERISA, which only allows for payments out of retirement plans in very specific ways. This is because retirement plans are usually paid for with pre-tax income, are not taxed in the years that they accrue, and then are only taxed once an employee retires and begins to take the money out. As a result, a withdrawal from a retirement plan before retirement age incurs a tax penalty. To avoid this tax penalty we divide up retirement accounts using a Qualified Domestic Relations Order (QDRO) which tells the plan administrator how to divide up the account because a divorce has occurred. A QDRO can be used to divide up either a defined benefit or a defined contribution plan.
With a defined contribution plan the parties determine how much of the money in the account was earned during the time of the marriage (the community portion) and then divide that portion equally between the parties. The spouse whose name is not on the account generally then has those funds rolled into his or her own separate IRA.
With a defined benefit plan, we again determine the community portion by dividing the number of months married during the employment by the number of months employed. We then divide this percentage in half to determine what percent of the monthly payment the spouse will receive when the pension begins to pay out. For example, if John works for Big Corp for 30 years and is married for 20 of those years to Jane, the community portion of the pension is 66%. Jane is entitled to 33% of the pension payments. When John retires and begins to collect a pension of $2000 a month, the QDRO would order that Jane receive $660 of that $2000 each month. Of course, in this scenario, Jane has to wait until at least the time when John is able to retire in order to receive portion of the pension.
This is a very basic outline. There are a lot of variations possible, especially based on how the pension is valued at the time of the divorce, whether the working spouse retires at the earliest possible date or continues to work past that date, and how the parties might agree to trade off retirement assets. As well, the drafting of QDROs is a very specialized field and many divorce attorneys hire a specialist to actually draft the document. For this reason it is always important to get legal advice from a qualified attorney before agreeing to the division of retirement assets.