Divorce is a challenging time for any couple, and one of the most difficult issues to resolve is property division. Retirement assets are a critical part of most couples’ financial futures; therefore, the division of these assets requires careful consideration.
Here’s what you should know about the division of retirement assets in a divorce, including the applicable laws, types of retirement plans, and division methods.
Laws Applicable to Division of Retirement Assets
The laws governing the division of retirement assets in divorce vary depending on the state. In most states, retirement assets are considered marital property, subject to division between spouses. State laws govern the division of retirement assets. Still, federal laws also come into play for some retirement plans. For example, the Employee Retirement Income Security Act (ERISA) is a federal law that governs most private retirement plans. In contrast, the Railroad Retirement Act and the Civil Service Retirement System govern retirement plans for railroad workers and federal employees, respectively.
Types of Retirement Plans
There are two main types of retirement plans: defined benefit plans and defined contribution plans. Defined benefit plans provide a guaranteed retirement benefit based on a formula that considers factors such as salary, years of service, and age. These plans are most commonly found in the public sector, including state and local government employees and teachers. On the other hand, defined contribution plans are funded by employee and employer contributions. They are typically invested in stocks, bonds, or mutual funds. Examples of defined contribution plans include 401(k) plans and individual retirement accounts (IRAs).
Methods of Division
There are several methods for dividing retirement assets in a divorce. One common approach is the “Qualified Domestic Relations Order” (QDRO), which is a legal order that directs the administrator of a retirement plan to divide the plan benefits between the divorcing spouses. Most defined benefit plans and some defined contribution plans, including 401(k) plans, require a QDRO. The QDRO must comply with ERISA and the plan’s rules, and a judge must approve it.
Another method for dividing retirement assets is the “Cash Out” approach. In this method, the retirement assets are divided by calculating the present value of the benefits and then distributing a portion of that value to each spouse. The spouse not receiving the retirement asset typically receives other property of equivalent value.
Finally, some couples choose to defer the division of retirement assets until later, such as when the retirement benefits are actually received. This approach can be complicated, as it requires the couple to agree on dividing the benefits and ensuring that the division is fair.
The division of retirement assets in divorce is a complex process that requires careful consideration of the applicable laws and the types of retirement plans involved. Working with an experienced divorce attorney and a financial planner is essential to ensure that the division is fair and equitable. With the right approach, it is possible to navigate the division of retirement assets and emerge from divorce with a solid financial foundation for the future.