Dividing Pensions & IRA’s
Nevada is a community property state, which means all property accumulated during the course of the marriage is owned jointly by the husband and wife. Under NRS 123 community property is equally divided during a divorce. It must also be equally split in a legal separation. This can happen through the couple assets themselves, with the help of a divorce attorney, or through the decision of a judge.
Property is often not given enough attention, because their value is not received until sometime in the future. The same goes for pensions and retirement funds that are part of a spouse’s employer-sponsored benefit plan. This includes Individual Retirement Accounts (IRAs), 401(k) plans, Simplified Employee Pension Plans (SEP) and pensions falling under the realm of the Employee Retirement Income Security Act (ERISA). Each spouse has an equal interest in the value of the other’s pension or retirement plan.
Types of Benefit Plans
There are a number of different types of retirement or pension plans. Here is a brief overview of the two main models.
Defined Benefit Plans
In these plans, the employer makes all the contributions for the employee, who contributes nothing. The employer sets aside funds for the employee’s retirement, usually in the form of an annuity. Upon retirement, the employee receives a monthly payment for the remainder of his or her life. The amount of the payment depends on the age, years of service and salary. This is an old-fashioned plan that many employers have replaced with a defined contribution plan.
Defined Contribution Plans
The employer establishes an account in the employee’s name. The employee contributes pretax dollars to the account and the employer deposits a matching amount up to a certain limit. Examples are 401(k) plans, SEPs, Keoghs and other similar plans. At retirement, the employee may choose to collect the benefit either as a lump sum or by way of periodic payments.
Valuing a Retirement Plan
Whether the plan is a defined benefit or defined contribution pension plan, the value of it must be determined in order to divide it. The value of a defined contribution plan is generally fairly simple: it is the balance of the account.
What is not simple is for the parties to agree on the valuation date. Do we divide the accounts based on the date the divorce was filed or the date the divorce is final? For an uncontested divorce those dates might not be too different. But contested divorces can take the better part of a year, or longer. Typically the courts will use the date the divorce is final.
Valuing the old-fashioned defined benefit plan is slightly harder. This plan must be appraised in order to determine its present value. This is usually done by an actuary or other professional and there are many factors that influence the value of the pension.
Qualified Domestic Retirement Order
A QDRO is issued by the divorce court to the retirement plan administrator ordering payment of one spouse’s retirement benefits to the former spouse upon the employee spouse’s retirement. QDROs are used to assign the assets of a pension plan that falls under the realm of the Employee Retirement Income Security Act (ERISA). This can include:
- union pensions
- defined benefit plans
- defined contribution plans (such as a 401(k) plan)
- public employee’s retirement benefits
What Does a QDRO Do?
This type of domestic relations order essentially assigns ownership of all or part of the assets in a retirement plan. The owner of the plan, the employee, is the “participant” and the other party is the “alternate payee.” The designated alternate payee must be one of the following:
- Spouse of the plan participant.
- Ex-spouse of the plan participant.
- Child of the plan participant.
- Dependent of the plan participant.
It’s important to note that a QDRO does not have to be included in the actual divorce decree. In fact, most are not. Most divorce decrees mention a QDRO shall be filed.
QDRO’s can be written by a divorce attorney, more are written by a CPA or pension benefits expert who understands the language needed for the pension administrator. Without this language the pension administrator will not divide the account.
What Must Be Included in the QDRO?
A QDRO is basically a set of written instructions to the retirement plan administrator as to how the pension benefits are to be divided between the two parties. In order to be considered valid and enforceable, a QDRO must include the following information:
- Full name and last known mailing address of all parties, including the employer, participant and alternate payee.
- Social Security numbers of participant and alternate payee.
- Formal name of the retirement plan and plan identification number.
- The terms of how the benefits are to be paid to each party, when they are to be paid and the amount of the payment or payments.
In the case of a defined benefit plan, the QDRO must include the length of time the benefits are to be paid to the alternate payee.
IRA Tax Penalty
Many retirement pensions utilize IRAs and SEPs. There are several different types of IRAs, but no matter which type is at issue, care must be taken in order to avoid tax penalties. Ordinarily, the Internal Revenue Service (IRS) imposes a penalty for early withdrawal of funds from an IRA. Additionally, any amount that is withdrawn is taxed as gross income.
The IRS makes an exception for withdrawals that are made for transfers in divorce cases, but only if:
1. The funds are transferred from one IRA into an IRA of the former spouse; and
2. The transfer is made in conjunction with a divorce.
The transfers must be carefully done to be sure all the intricate and complex IRS rules are followed. Otherwise, both parties may experience serious tax problems. Transfers or IRAs or SEPs do not require a Qualified Domestic Retirement Order (QDRO) which is required for employer-sponsored pension plans.
When you get to this step, talk to your divorce attorney to make sure you are doing everything correctly to avoid penalties.
Evaluating Pension Plans
Before negotiations begin or court orders are made about distribution, there is important information each spouse should discover about the other’s pension plans. This includes:
- Making certain all retirement pensions have been identified. Some employees have more than one pension at the same company or still have pension plans from former employment at another company.
- After all pension plans have been identified, obtain all information about each plan’s benefits. For example, a plan may reduce a former spouse’s benefit if he or she remarries. Also, the death of the employee spouse may terminate benefits.
- Checking to be sure the pension plan does not have a provision allowing it to reject court orders assigning benefits to a former spouse.
- Any other relevant pension information.
Swapping Pensions
Once the value of the retirement plan has been determined, one spouse may trade his or her interest in the pension plan for another asset of equal value. For example, the interest in the pension plan may be traded for the employee spouse’s interest in the family home.
Before this solution is agreed upon, the spouse who is giving up the rights to share in the retirement proceeds must consider both the short and long-term benefits and consequences of the trade. It would be wise to talk it through with a divorce attorney or CPA to fully understand the pros and cons.
Remember, if you and your spouse choose to do an joint divorce (uncontested), income earned during the marriage is community property. Which means that most retirement accounts are funding with community money and belong to both of you to a greater or lesser degree.
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