It’s not unusual that a couple’s assets with the most equity are the marital residence and various retirement plans. So, what do you want your life to look like post divorce? Do you want to keep your marital home? Do you want the security of a funded retirement plan?
It’s critical to understand your financial priorities post divorce as it takes strategic planning to achieve your goals. Engaging a CDFA™ (Certified Divorce Financial Advisor) or Divorce Financial Planner early in the process can be critical to a successful post-divorce outcome.
Distributions from Qualified Plans
One party might want to stay in the marital home so children can remain in the same school without interruption. Careful planning on dividing qualified plans such as a 401(k), 403(b), and SEP (Simplified Employee Pension Plan) can allow the nonemployee spouse to get distributions without incurring penalties before age 59½ that can facilitate a buyout plan or fund other “starting over” expenses.
While dissipating retirement assets is not often recommended, this might be the only source of cash available to achieve specific goals.
A Qualified Domestic Relations Order (QDRO) must be drafted to divide assets held in qualified plans. QDROs are legally enforceable orders issued to a plan trustee that contain specific instructions specifying exactly how the funds should be transferred from a qualified plan to the nonemployee spouse. These orders can direct that a portion be paid in cash and the balance put into an IRA that remains tax deferred. While income taxes must be paid on the amount that is distributed in cash, it provides the opportunity for a spouse under 59½ to draw from a retirement account without the additional 10% penalty.
There are more than 10 different retirement plans, each with its own specific rules and regulations for distribution, so it is critical to work with a professional to understand exactly what your rights and responsibilities are.
Distributions from IRAs
A QDRO is not necessary for division of an IRA. Distributions from IRAs under age 59½ can provide extra income for legal fees, start-up expenses or supplement income. Code Section 72(t) allows an IRA to be liquidated under a series of substantially equal periodic payments exempt from penalties. The only stipulation is that the amount that must be paid out is absolutely fixed, without exception, for 5 years or until the owner reaches age 59½, whichever is longer.
While this strategy fulfils immediate needs, it may result in a complete depletion of retirement funds. This can be avoided by dividing the recipient’s IRA into multiple IRA accounts. This will allow smaller distributions in hopes that financial opportunities might improve once the divorce is over and the focus on life begins again.
It’s rare when there are perfect solutions to the challenges of dividing assets. Not forming a clear picture of the life you want post divorce can result in poor settlement choices, leaving you confused and unhappy with the final results.
Do you know someone who is unhappy with their divorce settlement? Using a CDFA can help you avoid a similar fate.